There are many changes after a loved one passes away, including changes in tax responsibilities related to income received after death. It is easy to become quickly overwhelmed with these changes. There are new filing requirements, multiple taxes that may be at issue, new obligations to beneficiaries, and new concepts that most people do not encounter with on a regular basis. While every estate and trust have unique issues, knowing the basics can help you navigate these changes a little easier.
The Person Responsible for Managing an Estate or Trust
There are multiple roles and titles for the person who manages the assets of a person who passed away. If probate has been opened in a court to manage the assets the person owned in their own name, the person responsible is typically called a personal representative or executor of the estate. If the deceased individual created a trust during their life or at their death, the person that manages the trust assets is called the trustee. Fiduciary is a common term used to describe the person responsible for filing an income tax return for an estate or trust.
The Final Individual Income Tax Return
When a person dies, a final individual income tax return, Form 1040, usually must be filed. This is the same return filed annually, except instead of the tax year running the complete calendar year, it covers January 1 to the person’s date of death. All the deceased person’s income received after death during this specific period is reported on the final individual income tax return. Additional forms may be required, like Form 1310, to claim a refund due to the deceased taxpayer.
Estate Tax Returns
If a deceased person owned income producing assets in an individual capacity, like a savings account or brokerage account, those assets likely must go through the probate process. The deceased person’s estate becomes its own taxpayer with its own taxpayer identification number and tax filing requirements.
The estate income tax is often confused with an estate tax, but these are two separate taxes. The estate income tax is a tax imposed on the income an estate generates during the tax year. A return must be filed for every tax year the estate produces income above the filing threshold with a final return for the tax year in which the estate is closed. The estate tax is a one-time tax imposed on the value of the assets the deceased owned and is generally due nine months from the deceased’s date of death.
Estates have the option of two income tax filing periods, the calendar year, or the fiscal year. For calendar years, the estate’s first calendar year is the remaining part of the year after the person’s death. For example, if a person dies on October 5, the final individual tax return is January 1 through October 5. The first calendar year for the estate is October 6 to December 31. Every year thereafter, the estate income tax year is January 1 to December 31.
The fiscal year starts on the deceased’s date of death and ends in the month preceding the one-year anniversary of the date of death. For example, if a person dies on October 5, the fiscal year will end September 30 of the next year.
Both calendar and fiscal year estates have advantages and disadvantages. Like individual returns, calendar year estates run from January 1 to December 31, making it is easy to remember when to file. However, if an estate is open in more than one calendar year, multiple years may need to be filed. In contrast, because a fiscal year is always 12-months, the estate may be closed with less filed returns. Fiscal year returns can also defer the payment of income taxes for a longer period.
Trust Income Tax Returns
In addition to or in place of an estate income tax return, a trust income tax return may need to be filed for any trust created during the deceased’s life or upon the person’s death. When an individual creates a revocable trust, that trust generally does not need to file an income tax return during the taxpayer’s life for income trust-owned assets produce. The trust is considered a “disregarded entity” and the income is reported on the taxpayer’s individual income tax return.
Once the taxpayer dies, most trusts become irrevocable and cannot be amended absent special circumstances. The trust becomes its own taxpayer and must file annual trust income tax returns when it produces income above the filing threshold. The trust usually must file its return on a calendar year basis. However, in many cases an election can be made to include the trust’s income on the estate’s income tax return. Therefore, the trust may have a fiscal year if that election has been made by the estate.
Estate and Trust Tax Rates
Estates and trusts are taxed federally at significantly more aggressive rates than individuals. For example, in 2021, both estates and trusts are taxed at 37 percent on taxable income exceeding $13,500. In contrast, a single individual reaches that tax rate on taxable income exceeding $523,600.
Like the standard deduction for individuals, estates and trusts receive an income exemption that lowers tax liability. However, this amount is significantly smaller than individuals, ranging between $100 – $600, depending on multiple factors.
Estates and trusts are also eligible for income deductions. Common deductions include attorney and accounting fees. They can also receive deductions for income distributed to the estate or trust beneficiaries. This can include distributions made after the tax year ends if the proper elections are made. The income is then reported on the beneficiary’s income tax return and taxed at the individual’s tax rates.
Other Fiduciary Obligations related to Estate and Trust Income Taxes
A fiduciary’s responsibilities are not limited to the filing of appropriate tax returns and distributions to beneficiaries. The fiduciary may have a host of additional responsibilities that are not readily obvious. For example, the fiduciary may be required to render an accounting, which is a record that generally includes information about the assets, income, and expenses of an estate or trust. The accounting is usually an annual obligation and may be required under state law, local law, a will, or a trust.
Get Help from a Professional
A professional’s assistance can help alleviate concerns about the tax liabilities from income received after death and requirements for estates and trusts. A professional can help:
- Timely file the correct returns and additional forms.
- Make sure the estate or trust properly reports income, takes appropriate deductions, and makes timely elections.
- Prepare an estate or trust accounting that satisfies the fiduciary’s obligations to the beneficiaries.
Boulay advisors can assist you and your family with these difficult tasks and find the best solutions for you. Learn more by contacting a Boulay advisor at 952-893-9320 or learnmore@boulaygroup.com and asking about our estate and trust services.