Life is like a day. Sunrise, Sunset. A lot of us anticipate that we will die, later in life and if we are “fortunate”, life will give us notice before we do.
Unfortunately, we know, objectively, that is not always true. We all know someone that left us too early. I have had that happen 3 times, just since 6/7/18.
“Life is a movie. Death is a photograph” – Susan Sontag
When someone we love dies, our natural emotional response is grief. Taxes are the furthest thing from our mind-, and, as they should be. This is true for me and for many others that I know or have helped over the years. It is probably true for you, too.
Life dictates change, and even though we do not like it, sometimes our priorities need to change as well. There are things we must take care of, some of which can be time sensitive.
This blog was written to help others learn a little about death and taxes. In my experience, people are often very surprised (or shocked) to learn that tax returns may be required when someone dies. This blog is written in general terms because for many, state rules also apply. Ask your experienced Tax Professional for guidance, as needed.
There are three (3) possible IRS tax returns that may need to be filed after a death:
- The Final 1040
- Form 1041
- Form 706
- The IRS Final 1040 (Individual Income Tax Return)
- Income received prior to and including death is reported on the decedent’s Final 1040 tax return
- Upon death of the taxpayer a new entity, the estate, is created
- A revocable trust becomes irrevocable upon the grantor’s death. From that point on, do not report income on the grantor’s individual income tax return, use Form 1041
- The due date remains April 15 for calendar-year taxpayers
- Your first step, prior to starting the final Form 1040, is to determine who is responsible to file and sign the return
- If appointed, the representative files Form 56, Notice Concerning Fiduciary Relationship with the IRS
- The person filing the return should write “DECEASED,” the decedent’s name and the date of death across the top of Page 1 of the tax return. Mail the form to the IRS Service Center for the area in which the person signing the return lives.
- Form 1041: Estate Income Tax Return
- Income received after death is reported on IRS Form 1041
- Notice that Form 1041 and Form 706 both use the word “estate” – learn to distinguish between the two (2) Forms; Form 1041 is for income (like the 1040)
- An estate is comprised of all assets owned at the time of death, whether they are distributable through the probate process or an alternate way
- The decedent and their estate are separate taxable entities; obtain an Employer Identification Number (EIN) for their estate or trust from the IRS website
- The fiduciary of a domestic decedent’s estate, trust, or bankruptcy estate files Form 1041 to report:
- The income, deductions, gains, losses, etc. of the estate or trust
- The income that is either accumulated or held for future distribution or distributed currently to the beneficiaries
- Any income tax liability of the estate or trust
- Employment taxes on wages paid to household employees
Who Must File Form 1041:
Domestic Estate that has: Gross income for the tax year of
- $600 or more, or
- A beneficiary who is a non-resident alien
Domestic Trust that has:
- Any taxable income for the tax year
- Gross income of $600 or more
- A beneficiary who is a non-resident alien
Decedents Estates have an Exemption, but do not have a Standard Deduction.
- Decedents’ Estate : A decedent’s estate is allowed a $600 exemption
- Trusts required to distribute all income currently. A trust whose governing instrument requires that all income be distributed currently is allowed a $300 exemption, even if it distributed amounts other than income during the tax year
Form 1041 – Due Date
- Form 1041 is due by the 15th day of the 4th month after the end of the estate’s tax year. For taxpayers choosing a calendar year, the due date is April 15
- If you are preparing Form 706, you should prepare Form 706 at the same time as Form 1041 to determine where to report certain deductions
- Like IRS Form 1040, the Estate Income tax rate for Form 1041 is progressive, but the rates rise very quickly. For example, the 2017 rate is 39.6% for income of $12,500 or more
- The 2018 tax rate, inclusive of tax reform, is 37% for income of $12,500 or more
Important Form 1041 Takeaways:
Earlier in this post, I highlighted the following fragment in bold, any income tax liability of the estate or trust, and now, I will explain why I did this.
Uncle Sam, generally, may need to be paid before money is distributed to heirs. I am not providing you specific tax advice, nor am I providing you legal advice. However, I am sharing what I have learned via education and experience because this is something that a lot of people do not know and mistakes can be painfully expensive.
Cancelled debt, can trigger taxable income, which can result in an expensive IRS tax bill.
For example, one client received a 1099-C for student debt that was cancelled after the death of a family member. This triggered a large tax bill because of information shared earlier; i.e. a $600 exemption and a 39.6% tax rate. Exceptions, such as bankruptcy or insolvency, were not options.
Fortunately, recent tax reform changed this rule effective January 1, 2018:
Discharged of Student Loan Indebtedness
“The exclusion from income resulting from the discharge of student loan debt is expanded to include discharges resulting from death or disability of the student.”
A 1099-C may be issued for other forgiven deceased debt, such as credit card debt. Be prudent, and know your federal and applicable state rules before distributing assets to heirs. Your attorney may be a good resource to help guide you through this process.
3. Form 706: Estate Tax Return
This form is used to report the transfer of assets from a decedent at the time of death.
The government imposes federal estate tax on the decedent’s entire estate. It is an excise tax on the right to pass property at death.
The Gross Estate includes the total value of the decedent’s interest in all property owned as of the date of death which can transferred due to the will or law. The form includes a number of schedules on which the estate lists the various assets or includes the expenses.
The theory behind the transfer tax system is to tax the value bequeathed to heirs. Since certain debts need to be paid and funeral expenses are customary, these amounts never become part of the inheritance. Because of this, the estate accounts for expenditures and debts in addition to assets.
Form 706 is due exactly nine (9) months after the date of death, unless the IRS has granted an automatic six (6) month extension of time.
For decedents who died in 2017, the executor of the Estate of every U.S. citizen or resident, files Form 706 for those:
- Whose Gross Estate, plus adjusted taxable gifts and specific exemption is more than $5,490,000; or,
- Whose executor elects to transfer the DSUE (Deceased Spousal Unused Exclusion) amount to the surviving spouse, regardless of the size of the decedent’s gross estate
Recent Tax Reform, the #TCJA, doubled the Estate Tax and Gift Tax Exemption, for estates of decedents dying and gifts made after December 31, 2017, and before January 1, 2026. The exemption increased to $11,180,000 for 2018.
Non-Resident Filing Requirements
Use Form 706-NA, to compute estate and generation- skipping transfer tax liability for nonresident alien decedents. If an individual who is a nonresident alien has a gross estate of property located in the United States in excess of $60,000, an estate return is required.
In closing, Ben Franklin is often credited for saying: “Tell me and I’ll forget. Teach me & I may remember. Involve me & I learn.” I write because it is one more way I can help others from getting hurt financially.
I hope this blog helped you learn a little about death and taxes. The information provided was written to provide a broad perspective; individual facts and circumstances need to be reviewed to determine what, if any, tax returns may apply for you (or for those that you love).
If I can answer questions or help you, please let me know.
Thanks for reading,
Deborah Ann Fox, CPA helps Small Business Owners & Individuals build and protect their financial wealth though education, strategy, and proactive tax planning. Deb thinks this is the fun part of tax because it makes a financial difference for her clients, their business, and their families.
She offers free 30 minute no obligation consultations. We can discuss/resolve via a mix of e-mail, phone, virtual, and in-person communications.
E-Mail me @ email@example.com
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The blog is provided as general information only and should not be considered a substitute for specific advice and services of a Certified Public Accountant, Enrolled Agent, or an Attorney