It can be a sad topic but certainly an important one. I love working with estates and trusts because each has its own unique circumstances, which is intriguing to me. I enjoy assisting people through the various rules and trying to save tax dollars. When preparing these returns, it’s all about paying attention to the cut-off periods.  Below is a brief review of filing requirements for someone who passes away and defining the language used when preparing tax returns for the demised.

Income Tax

If an individual dies during the year, the personal representative probably needs to file a final individual income tax return, Form 1040.  Also, a state tax return may need to be filed depending on what state in which the decedent resided. The income and expense reported on the Form 1040 should be from January 1st, through the date of death.  The IRS does not prorate the standard deduction or exemption amount for deceased individuals. Here is an example:  Tessa passed away on May 20, 2017 at the age of 55.  Her income consisted of: interest income earned through May 20th of $3,441, rent income of $5,000, rental expenses of $1,257 and wages of $16,875.  Her standard deduction is $6,350 (single) and personal exemption is $4,050.  Tessa did not have enough to itemize her deductions.  To decide whether Tessa has a filing requirement, you add up the income $3,441 + $5,000 + $16,875 = $25,316.  Since this amount is greater than the total of the standard deduction of $6,350 and personal exemption of $4,050, total $10,400, Tessa has a filing requirement and her personal representative should file a federal income tax return for Tessa.  If Tessa’s income would have been below $10,400, there would not be a filing requirement.

The day after a person dies, a legal entity known as an “estate” is created if the decedent’s assets are not titled in a trust.  An estate entity is called a fiduciary, which reports income and expenses to the IRS using the date of death as the beginning of the estate period.  For tax purposes, the year end of an estate is the month ending before one year after the date of death.  For example, if a person dies on June 10, 2017; the start date of the estate would be June 11, 2017, and the year-end date would be May 31, 2018. The filing due date would be 3 ½ months after the fiscal year-end or September 15, 2018.  The estate entity is temporary as it merely assists with liquidating estate assets and/or transferring property to the beneficiaries.  When the estate has no more assets or liabilities, it is closed and a final fiduciary income tax return is filed with the IRS.

Estate Tax

 For 2017, an individual could be subject to federal estate tax if their assets are valued at $5,490,000 at their date of death.  The estate tax rate is 40 percent.  If the deceased is married when he or she dies, generally all or most of the assets pass to the surviving spouse where a marital deduction decreases the taxable estate to an amount below the $5,490,000 exemption. As such, generally no estate tax is due when the first spouse dies. Each year the exemption amount is subject to a cost of living increase.

If the decedent is subject to a federal estate tax, there is an estate tax return filing requirement on Form 706, due 9 months after date of death.  If the first spouse to die’s assets are not greater than the exemption amount of $5,490,000, you can still file a Form 706 to claim the unused exemption for the surviving spouse.  This is called “portability”.  Here’s an example:  Bob died with assets valued at $4,000,000 at his date of death.  The personal representative filed a Form 706, federal estate tax return, for Bob to report the $1,490,000 unused exemption ($5,490,000 – $4,000,000) which can be used by the surviving spouse at her date of death.  If the surviving spouse, named Bella, died in 2017, her exemption amount would be $5,490,000 + $1,490,000, total of $6,980,000.  If Bella’s assets are $7,000,000 at her date of death, she could claim an exemption of $6,980,000 against her total assets for a taxable estate of $20,000, ignoring any deductions for this example.

On the other hand, if Bob would have died a single man with assets worth $6,000,000, he could potentially be subject to an estate tax of $204,000 ($6,000,000 less $5,490,000 exemption X 40% = $204,000).  For simplicity, this example ignores any deductions, like debts or estate administration costs. The federal estate tax area is much more complex than these very simple examples.  Estate planning is highly recommended if your net worth is close or greater than the exemption amount because of the 40 percent estate tax rate.  Don’t put your family in a taxable situation if it can be avoided. Call the KTLLP Estate Planning team today.