The last thing on your mind when a loved one passes away is the IRS, but with a bit of proper planning the task of filing the final tax return can be painless and (somewhat) stress free.
Before we begin, please know that tax laws are always subject to change, every situation may be different, and exceptions may apply to the following tips. It’s always best to consult a financial professional and the IRS Publication 559 for every tiny detail.
The EIN Number
The executor must request an EIN (employer identification number) for the deceased. This number will be used to prepare the final tax return for the estate; it will also be used by anyone paying interest or dividends to the estate.
Before & After
The first thing to know is that income for your loved one during their final year will be split into two categories:
- Income received while they were still alive
- Income received after they passed away
Income received while they were still alive is filed in the usual manner via the standard 1040 form. Write “Deceased” at the top of the form, along with the name and date of death. In the appropriate boxes, include the name and address of the spouse (if it’s a joint return) or the name and address of the executor (if it’s not a joint return). Keep track of tax credits, as those still apply during the portion of the year the person was alive and will benefit the spouse or dependants.
Income greater than $600 received after the person passed away should be filed as a tax return for the estate and trust via a 1041 form.
Things get a bit trickier when it comes to declaring medical expenses for elders. If an elder passes away, the medical costs that have not yet been paid are now liabilities of the estate and should be included on the estate tax return. If the elder was a dependant, the dependant may deduct the medical expenses of that year, regardless of if they were paid before or after the elder’s death.
Federal & Estate Taxes
The federal estate tax rate is at 40% for 2017, with an exemption of $5.49 million. This means that if the estate is valued at less than $5.49 million, the estate will not have to pay any federal taxes on those assets, and heirs will receive those assets in their entirety. When it comes to locale estate taxes, some states have inheritance tax, some have estate tax, some have both, some have none at all. [Dig Deeper: State-By-State Estate And Inheritance Tax Rates]
That said, estate tax isn’t the only thing that needs to be managed -- for example, there’s Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return. Since there are a number of other tax issues to consider when settling an estate, it's generally a good idea to work with an estate attorney or financial expert to determine the amount and types of taxes you'll need to pay.
The final step can be the most important. By filling out the Request for Discharge From Personal Liability, the executor limits their liability should any new or additional taxes pop up within nine months of filing the request. Consider this the punctuation mark of your time as an executor. Everything was filed for that year and you can now move on with your life.