I get many questions about estate taxes, especially after the executor or trustee has struggled through preparing them and found that it is not the “walk in the park” they thought it would be. Filing your own income taxes can be such a headache! But if you became the Executor, Personal Representative or Administrator (aka “estate fiduciary”) for the estate of someone who died last year, you’ll have additional filings and considerations. This week, I decided to answer a list of 10 questions I am commonly asked.
Understanding these ten items will help estate fiduciaries. Though framed around court-appointed estate fiduciaries, Successor Trustees also should pay attention.
#1 Who Has Responsibility to File the Estate Income Tax Return?
If you are the court-appointed Executor, Administrator, or Personal Representative, you have the tax job. In this role, the court has confirmed you to handle all final business on behalf of the person who died. You are known as the “estate fiduciary” and have the legal obligation to act in the best interest of the decedent.
(Just being nominated in someone’s Will does not make you the executor, administrator or personal representative. You must have the probate court’s order appointing you. Generally, the information in this article applies equally to trusts – but in slightly different ways – if you became successor trustee on a decedent’s trust. For example, you do not usually authenticate a successor trustee through court. Instead, trustees must produce legal documentation of your right to be successor trustee to conduct the business required. For example, to handle bank business, Successor Trustees must show death certificates, memoranda of trust, acceptance of trusteeship documentation, etc.)
Typically, fiduciaries are entrusted with the care of money or property and are legally liable for handling it properly. The law says that includes all the decedent’s tax issues and all the estate tax issues—income, death, and generation-skipping taxes. This article addresses fiduciary income taxes only.
If your estate is subject to death and/or generation-skipping tax issues, that is because it is worth many millions of dollars. People who run estates of such a size are rarely silly enough to try to do it themselves and they carefully hire tax counsel.
#2 You are personally liable if you do not do the tax part right!
Many people fail to understand this point. They mistakenly think they do not need a lawyer with tax expertise. They assume their accountant will understand fiduciary income taxes, when in fact, the opposite may be the case.
As the fiduciary trusted with this responsibility, you must file the last income tax returns for the decedent. However, you have the larger responsibility of closing out all tax business, so you may also need to address back tax issues. Most likely, you will have to file at least one fiduciary income tax return for the estate and/or trust. Often, there are more.
Some fiduciaries attempt to file the returns themselves. However, the rules are different. It is not like filing a 1040. A surviving spouse can file the last tax return, jointly, with the decedent. Regardless, if the spouse is not the court-appointed executor (administrator or personal representative or documented trustee), he or she does not have the legal authority sign the joint return, or even to file the returns at all.
#3 Why must you file an Estate Fiduciary Income Tax Return?
The estate fiduciary must file a federal income tax return (Form 1041) for several different reasons that don’t always have to do with the income of the estate. It is important also to know that this has nothing to do with the decedent’s 1040. The 1041 is filed for the estate – the final earthly business of a person.
Since fiduciary income tax laws vary from year to year as do many other tax laws, it is best to see a professional about the duty to file and the deadlines.
#4 What kind of Income does an Estate have?
Estates that have any payments due to the decedent have income that may be taxed at absurdly high rates compared to individual rates. Income paid before the death goes on the 1040. If the income is paid to the decedent after the date of death, that income does not go on the 1040. (There are a number of ways to completely plan around the fiduciary income tax. However, you need a fiduciary tax professional to advise you because these ways largely involve manipulating distributions and truly understanding the laws affecting taxable interests like IRAs.)
There are many less than intuitive rules. For example, suppose you were distributed a car from an estate and the car was worth $50,000. Then, let’s say the estate happened to have $50,000 in taxable income that year and made no other estate distributions. What happens? The person with the car has to pony up the taxes that the estate would have otherwise owed – even though the person with the car did not receive any of the cash income. Under the law, the person in possession of the car is deemed to have received the income.
Of course, there are more rules and there are exceptions to this general rule. Just make sure you go to a professional that knows the rules.
#5 How do you file Estate Income Tax Returns?
As with all things IRS, you must use the correct forms and identifying information.
- When you become an Executor, you must establish the deceased person’s estate as a separate legal entity for federal income tax purposes. This requires a copy of the person’s death certificate and your court order appointing you as executor. (For a successor trustee you’ll provide the certificate and the trust and acceptance documents previously mentioned.)
- You will need these to jump through the IRS hoops necessary to obtain a taxpayer identification number (TIN) for the estate’s legal identity. This is not a form to be taken lightly. For example you choose the estate’s tax year. It does not have to be a calendar year and there are good tax lowering reasons not to choose a calendar year.
- Form 1041 is the income tax return form for estates. A box is at the top to check for “Decedent’s estate” as opposed to a trust return.
- The 1041 is sometimes referred to as the “fiduciary income tax return” rather than the Estate Income Tax Return. That is because an executor is a fiduciary, someone entrusted with another person’s money and the legal duty to act honestly and in the best interests of the estate.
- The return is due to the IRS three and a half months after the end of the estate’s tax year. If you get stuck with a calendar year then it is due on April 15 just like the decedent’s 1040.
- The executor files the return under the name and TIN of the estate.
- The return reports estate income, gains and losses, and claims credits and deductions for the estate.
- The executor submits the completed 1041 form and all requested documentation to the IRS office for your state. Oklahoma and many states file 1041s in Ogden, UT. Other states file in Kansas City, KS. You can check the location for all states on the IRS website.
- If you are completing the deceased person’s personal income taxes as well, do it on the regular 1040. When you established the TIN, the IRS flagged all future filings as being for a deceased person.
#6 What Tax Year is being Filed?
The estate’s tax year begins on the date the deceased person died and ends on the date chosen by the executor as long as it ends no later than the last day of the month that precedes the date of death. Thus, if the person died on April 20, the estate’s tax year ends no later than March 31 of that year. The tax period must end on the last day of a month. If you choose an estate year to end in any month except December, the estate has what is called a fiscal tax year or non-calendar tax year instead of a calendar tax year.
If the estate is closed after the first filing, the first tax return may be the last. If the estate is not closed within a calendar or fiscal year, you most likely will have to have to file in other years.
#7 Do estates get Tax Deductions?
Currently, for all estates, there is a $600 exemption. Other deductions include:
- Administrative expenses. The amount you spend managing the estate is deductible. These may include expenses for collecting assets, paying debts, and distributing property to the heirs and beneficiaries. Deductible costs also include probate filing fees, the cost of publishing court-required notices in the newspapers, and the cost of your bond. An executor or fiduciary bond is a type of insurance policy to guarantee you won’t misuse estate assets. It’s a waste of money if you have named an honest, intelligent executor who is not a procrastinator. Don’t name someone who does not know that they will need help to proceed on the tax front at least.
- Beneficiary distributions. The estate can take a deduction for the amounts you are required to pay to beneficiaries from income on estate assets.
- Executor’s fees. If the estate paid you as the executor during the year, the amount can be deducted from the estate’s income. As executor, you must report the fees as taxable income on your own personal income tax return.
- Professional fees. The estate deducts amount paid to attorneys, accountants, tax preparers, appraisers, etc.
- Miscellaneous deductions. Certain expenses like office supplies, postage, safe deposit box, and travel expenses may be deductible.
#8 Who Pays the Tax?
As executor, you are responsible for making sure that the fiduciary income taxes are calculated, filed and that the estate pays all fiduciary income tax due. However, not knowing how to avoid the tax is a big problem for those who do not seek tax advice early in the process. The money is due, even if the paperwork is deferred.
When the tax is unavoidable, it is paid from estate assets, not your personal funds. That is, unless you do something wrong. Remember that you have personal liability for handling the estate properly. The Courts consider not knowing what you are supposed to do the same as doing something wrong. You will get no sympathy. Also, the beneficiaries may sue you, if the tax discrepancy is large enough.
#9 Do Beneficiaries also file an Estate Income Tax Return?
Beneficiaries do not file estate or fiduciary income taxes. Instead, they are responsible for paying their own income tax on what they received when you distributed income to them.
As executor, you must give Schedule K-1 Forms to beneficiaries. When you file the estate’s Form 1041, each beneficiary’s Schedule K-1 form must show how much of the taxable income and deductions the beneficiary received or is deemed by the Court to have received during the tax year.
Each beneficiary should get a K-1 for every year you distribute to them. They will use this information to file and pay their own income taxes. Theirs, most often, will be less than the tax the estate would have had to pay if the income were not distributed.
#10 When do you NOT have to file an Estate Income Tax Return?
If all the estate assets are distributed right away to the people who inherit them, the estate may not have income to report. That, however, is almost impossible. Well-drafted estate plans most often include a survival clause that prevents any immediate distribution. It also takes some time to hire a lawyer and file in court to have the power to make such distributions. From Wills or probate, early distributions involve extra court orders and are largely not allowed by the courts if there are still debts to pay.
NOTE: Please remember that we are addressing estate income taxes here, not taxes for the wealthy or federal gift or generation-skipping taxes. Our website handouts page has information on estate and gift taxes for large estates, plus information on other estate questions you may have.
I hope these answers help you determine what to do about estate income tax filings and payments on estates you manage. Like everything in the law, you can do these tax filings yourself. However, to do that you must educate yourself in tax law well beyond the nuggets shared in this article. I don’t recommend it. Ideally, hire an estate tax attorney who will help you with both the estate administration and the taxes. You could also pair an estate attorney with a CPA who specializes in fiduciary tax returns to be absolutely sure you are handling this matter correctly. Either hire the attorney with the estate tax credentials or an estate attorney plus a CPA with fiduciary tax specializations. Do not hire one without the other.
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