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Taxes and Estate Administration

Benjamin Franklin said “nothing is certain except death and taxes.”  Unfortunately, these are not mutually exclusive.  Tax obligations continue on despite the passing of a loved one, and in some cases, come about because of it.  Tax deadlines pose a challenge for grieving families.  It is important to see an attorney and a tax professional to help you through the steps that follow a loved one’s passing.  You need someone to help identify the best way to handle your loved one’s estate, keep you on track to meet the deadlines, and overcome difficulties that arise along the way.

In this article, I will discuss the tax returns that can arise as part of a decedent’s estate, what the surviving spouse or personal representative may be required to file, and some of the pitfalls to be aware of.

Final Income Tax Returns

There is always one final personal income tax return due after a person passes away.  This is required for income received during that tax year, up to the date of death.  Marking the return as a final return alerts taxing authorities to close out the decedent’s tax accounts.  If the tax accounts remain open, taxing authorities may expect further returns and audit the deceased loved one.  You should file final personal income tax returns for any decedent, even if they did not have enough income for it to be required, to ensure their tax accounts are closed out. 

The decedent’s final income tax return is filed by their surviving spouse or the personal representative of their estate.  If there is a surviving spouse, the final income tax return is their joint return.  Otherwise, the final income tax return should be filed by the personal representative of the estate.  Any tax owed should be paid from the estate.  If there is a refund due to a decedent, the IRS will not release it to just anyone.  Your tax professional will need to file an additional form and include an original of the order appointing you as the personal representative of the estate to claim the refund.  The IRS will not issue the refund without this.

Inheritance Tax Return

The Inheritance Tax Return is a state tax filing that applies to property inherited from any decedent who was a resident of Pennsylvania.  The tax is based upon the relationship of the heirs.  The inheritance tax rate is 0% for a spouse or a qualifying charity, 4.5% for children or grandchildren, 12% for siblings, and 15% for any other person who receives an inheritance. 

An Inheritance Tax Return and tax payment is due even if no estate was opened.  There is a discount if the tax is paid within 3 months after the date of death.  You should hire an attorney soon after the loved one’s passing to help with estate administration and inheritance tax. 

Fiduciary Tax Returns for a Decedent’s Estate

While the Decedent’s Final Income Tax Return covers any income received during their lifetime, income received by the estate after the decedent’s death is reported on Form 1041 and PA-41.  For a typical estate, this may be minimal, consisting only of a small amount of interest.  The estate receives stepped up tax basis in property, so there will be little to no capital gains or gains on the sale of property, so long as it is promptly liquidated after the date of death.  In a more complex case, there could be various forms of income after death requiring complex tax filings. 

You should promptly hire an attorney to assist with an estate administration, and administer investments and real estate as quickly as possible and make sure the estate’s checking account is not earning interest, to avoid additional tax obligations.

If a Fiduciary Return needs to be filed, the filing deadline will vary from one estate to the next.  These returns are on a fiscal year based on the date when you applied for the EIN for the estate.  Make sure you are aware of this, and work with a tax professional to prepare the return. 

Fiduciary Tax Returns for a Trust

                If you are administering an estate, you need to be aware of any trusts that are currently existing and any trusts provided for in the will.  Currently existing trusts will need to be administered on an ongoing basis after the decedent passes until such time as it may be necessary for the trust to be dissolved.  Depending upon the provisions in the trust and the assets in the trust, it may continue on in existence for a very long time, or it may need to be dissolved very quickly after the decedent passes away.  If there is a trust provision in the will, that may require you to begin a new trust after the date of death, which will provide for the needs of one or more beneficiaries. 

                Most Trusts file a Form 1041 and PA-41 Fiduciary Return to report the Trust’s income and distributions.  This should be prepared by a tax professional who is familiar with the Internal Revenue Code’s provisions regarding trusts and has reviewed the trust instrument. 

You should review the decedent’s tax returns, but you cannot necessarily rely upon the way the decedent handled taxes for a trust during their lifetime to tell you how you should file tax returns after they pass.  Grantor Trusts, a popular tool used for estate planning purposes, have an unusual tax treatment.  During the Grantor’s lifetime, the Trust’s income gets reported on the Grantor’s 1040 personal income tax return as though the Trust did not exist.  As soon as the Grantor passes away, the tax treatment of the Grantor Trust suddenly changes.  At that point, the Trustee will be required to file Fiduciary Returns for the Trust each year it continues to exist and generate income. 

                Alert your attorney and accountant right away if there is a Trust.  The tax provisions for trusts in the Internal Revenue Code are highly complex.  You should have an expert analyze the Trust instrument and determine how taxes should be handled. 

Kelly Walsh Appleyard, attorney