“…but in this world nothing is certain but death and taxes.”
– Benjamin Franklin
Not only are death and taxes a certainty in this world, but death itself brings with it a whole new world of taxes. In life, most individuals only need to deal with individual income taxes and possibly gift taxes. Or if he or she has a business, then of course there are additional business tax returns that must be dealt with. But with death comes a whole range of additional tax responsibilities for the often unsuspecting Personal Representative.
Before we proceed with itemizing the particular tax responsibilities, it needs to be made clear that the Personal Representative has a fiduciary responsibility to ensure that all tax returns related to the estate are filed in an accurate and timely manner. Just as an individual is subject to penalties and interest for the failure to file or inaccurately file his or her personal tax returns, the Personal Representative can be held personally liable for inaccurate or late filed returns for the decedent or his or her estate. This duty is not one to be taken lightly, and the prudent Personal Representative will take immediate steps to understand what taxes need to be filed and when.
So, what taxes are we talking about? There are several different types of taxes that may be involved as follows:
1. Decedent’s final individual income tax returns: The Personal Representative is responsible for making sure that the decedent’s final federal and state individual income tax returns for the year of death are filed. These returns will include income and expenses for the period from January 1 through the date of death, and the remainder of the income for the year will be reported on the income tax returns for the estate, which we will discuss momentarily. Additionally, any unfiled tax returns or outstanding tax issues, including gift tax returns and issues, must be appropriately handled. Depending on the decedent’s personal tax situation, the preparation and filing of these returns alone can be quite an undertaking.
2. Income tax returns for the estate: Although a person has passed away, his or her assets continue to earn income that must be reported on a tax return. But the income earned after the date of death technically should not be reported under the individual’s Social Security Number (SSN) and thus should not be reported on the decedent’s final individual income tax returns. Instead, the estate which immediately comes into existence at death must file separate fiduciary income tax returns under an Employer Identification number (EIN) that the fiduciary needs to obtain as soon as possible after death and provide to all payers of income. As one might imagine, it is almost impossible to prevent some items of income from being incorrectly reported under the decedent’s SSN resulting in incorrect 1099’s and other tax documents being issued. This can be dealt with by making an allocation between the final individual returns and the initial fiduciary returns, but obviously, the sooner the Personal Representative notifies payers of income the better.
3. Estate taxes: In addition to the income taxes that must be paid on the income earned by an estate, there also may be an estate tax which is a tax imposed on the net value of the assets in the estate on the date of death. Understanding the difference between these two taxes is extremely important but often very difficult for an inexperienced Personal Representative to grasp. The need for filing an estate tax return is dependent upon the size of the estate and the year of death. It has changed dramatically over the past few years and will most likely change again in the near future. It is imperative that the Personal Representative be aware of this tax and the related filing deadlines and possible elections that can be made. The fiduciary must also check the state estate tax laws carefully. It is possible to have an estate that is not subject to federal estate taxes but is liable for state estate taxes. In addition, if the decedent had assets in more than one state, it is possible that the estate may be liable for state estate taxes in multiple jurisdictions.
4. Inheritance taxes: Inheritance taxes are imposed by some states on the value of assets passing to the beneficiaries. Not all states have an inheritance tax, and the rules in those states that do have an inheritance tax vary from state to state. The inheritance tax is not tied to the estate tax, and the Personal Representative must be sure he or she fully understands the appropriate state inheritance tax laws and applicable due dates.
Taxes at death are far from simple, and the uninformed Personal Representative can quickly find himself or herself in serious tax trouble. One of the first steps in administering an estate should be a consultation with a good estate attorney, but it should be quickly followed by a visit with a good fiduciary accountant.