In the July 27th post at PwPpartners.com, we discussed asset estate returns: when they are required, what is included, and when to file them. Today’s discussion is about income estate returns: when to file, common deductions, and items that cannot be deducted. The first step to determine if an income estate return needs to be filed is to review the income earned in the year of death.
We see a lot of confusion regarding filing a final income tax return for a deceased individual. Many people believe any income paid to the decedent in their final year of life belongs on their final tax return. This is not true. Any income paid from January 1st to the decedent’s date of death is included on their final tax return. Any income after the date of death belongs to the decedent’s estate.
For example, consider a family member who dies on September 30th and has a high interest-paying bank account. Any income the account earns after September 30th belongs to the decedent’s estate. It will continue to belong to the estate until the asset is distributed to the estate’s beneficiaries. Accounts with beneficiaries like IRAs, 401(k), and life insurance to not belong to the estate. They belong to the beneficiaries listed on the accounts who will pay any taxes necessary.
An estate return is required to be filed if the estate generates more than $600 of gross income during the year. Estate income includes, but is not limited to: dividends paid, interest earned (including on savings bonds), capital gains and losses on stock sales, partnership income and losses, sale of property, sale of collectibles, rental income, and S corporation income and losses. Wages earned before death but received after death belong to the estate.
For example, Bob has owned a rental property. The tenant is still paying rent. Any rent collected after his date of death would be considered estate income. If Bob’s rental property generates more than $600 after his date of death in the estate tax year, an estate return is required to be filed.
There are allowable expenses that can be deducted on an estate return. Common expenses like court and attorney’s fees to probate the will, appraisal fees, tax preparation fees, business expenses, rental property expenses, interest expense, and state and local property taxes are deductible. Charitable contributions are allowable if the will requires a contribution be made from gross taxable estate income. We are frequently asked if funeral expenses, medical expenses, and primary residence expenses or utilities are deductible. These expenses are not deductible on the estate return. If there is net income on the estate return, there is a tax liability to be paid. The tax rates on an estate with income range from 10% up to 37%.
Calendar year estates are required to file the estate return by April 15th of the following year. Fiscal year estates are required to be filed by the 15th day of the 4th month following the close of the estate tax year. A fiscal year estate begins the day after death and runs until the last day of the month before the one-year anniversary of death. There are benefits to both calendar year and fiscal year estates. Discuss with the tax preparer, which option is more advantageous when the estate is being setup.
In many cases, you can avoid having an income estate by naming beneficiaries or putting property into a trust to transfer to beneficiaries directly after you pass away. Working with your attorney and financial planner or advisor to plan ahead can make your passing a little less stressful by streamlining the process of assets transferring.
