An Executor’s Guide to Taxes

Administering an estate can be a daunting and tiring task. It’s likely something you’ve not done before and may never be called on to do again. Among the many duties you have is making sure taxes for the deceased and the estate are in good order before closing the estate. This can be overwhelming as thinking about your own taxes can be scary enough! Here we’ll discuss considerations around this aspect of your fiduciary obligation.

individual basis as appropriate. Note that you’ll Income Tax Filings of the need proof of your role as executor for a taxing Deceased authority to speak with you, e.g. letters Just as you are accustomed to filing your own testamentary. A financial power of attorney for the income tax return, you’re now responsible for deceased will not be helpful in this situation as making sure the deceased’s last income tax return these are void after death. is filed. This may be a joint return with a surviving spouse or a return for only the deceased if he/she What do you do if you don’t have tax-related records for the deceased? I often find executors was not married at death. The final return could are missing some or even all of a deceased’s tax also be a jointly-filed return for both deceased spouses if they passed away in the same year. If records. This can be because the deceased’s you are the executor for an individual who was estate plan was disorderly or absent, address married at his/her death, you’ll need to coordinate changes, lack of access to electronic accounts, or this final tax filing with the surviving spouse or the volume of documentations may be such that executor of the other spouse’s estate if this isn’t something is invariably misplaced. The first step is you. In addition to a federal income tax return filed to see what income documents can be obtained on Form 1040, a state income tax return may also from employers, financial asset custodians, and be required depending on the deceased’s state of other tax form issuers. If income activity may still residence/domicile and states where the deceased be missing, the next step is to contact the IRS for a wage & income transcript for any years in question. owned income-producing property or had business activity. In addition, some income activity may need to be created, e.g., if the deceased owned a business or rental property. Keep in mind that tax documents Not only must the deceased’s final tax returns be and IRS transcripts typically cover only items of filed, you’ll also want to make sure there aren’t any income. Although an IRS transcript will likely show other years for which the IRS or other taxing mortgage interest as reported on Form 1098, authorities are expecting tax returns or tax information for other itemized deductions such as payments. For example, if the deceased owed the medical expenses, state taxes, and charitable IRS several years of back taxes, these must be contributions will have to be created from the addressed before closing out the estate. If you are deceased’s bank records or other documents. at all unsure about this, a phone call to the IRS is Additionally, IRS transcripts may not show the the best starting point. Request a compliance correct cost basis for the sale of financial assets check to see if any returns or balances due are and will likely show no cost basis for any sales of outstanding and also to see if any overpayments may be on file. States can also be contacted on an real estate, so further work will be required for these types of transactions.

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Individual income tax returns are generally due It’s also possible that both the estate and the April 15th of the year following the deceased’s beneficiaries have taxable activity for the same death. This can sometimes cause the closing of the period. If an estate distributes property to estate to be delayed even if all else is resolved. beneficiaries in the same tax year it generates For example, if the deceased died in February taxable income, it’s possibly the beneficiaries may 2019, the 2019 Form 1040 can’t be filed until be required to include their share of the estate’s nearly a year later. On the other hand, you may income in their own personal tax returns. Included have an estate that will take some time to close. If in Form 1041 is a Schedule K-1 that reflects a you need additional time to gather information for a beneficiary’s share of an estate’s activity to be complete and accurate tax return, an extension of incorporated into the beneficiary’s personal tax time can be requested which gives you until situation. You’ll want to understand as soon as October 15th of the year following the deceased’s possible in the estate administration process what death to file his or her final Form 1040. Keep in tax impact there may be to beneficiaries so that mind extensions do not extend the time to pay any you can communicate this information to them. taxes owed, so late payment penalties and interest Beneficiaries may have no idea that receiving may accrue if balances are owed with the returns money from an estate could have an income tax when filed. consequence to them. As a best practice for properly completing Schedules K-1, obtain beneficiary Social Security numbers in advance of Income Tax Filings of the issuing distributions as these may be difficult to Estate obtain after beneficiaries have received their share The estate is the entity that exists from the of estate assets. deceased’s date of death until the deceased’s property is completely distributed to beneficiaries The deceased’s will may include a provision for and the estate is closed out with the appropriate what’s known as a testamentary trust, i.e., a trust court. While in existence, the estate’s assets may that comes into being upon death. If so, consider generate income, e.g., financial account earnings that this newly-created trust may also contain or sale of real estate. If $600 or more of income is assets that generate income and, as such, may generated by the estate, it will likely have a federal also need a tax return of its own. You as the income tax filing requirement. Just as individuals executor may or may not also be the trustee of a file Form 1040 to report their taxable income, testamentary trust. In a very specific set of estates file Form 1041. As you are working with the circumstances, the estate and such a trust may attorney helping you administer the estate, it’s even file one Form 1041 to report their combined likely he or she will obtain for a federal tax ID (also activity. This may or may not be feasible or called EIN for Employer Identification Number) desirable depending on the trust’s trustee, from the IRS which is the identification number beneficiaries of the trust and estates, etc. under which you will file Form 1041. Note that the estate may choose a fiscal year and that the Other Tax Filings accounting period for an initial filing is allowed to In addition to Form 1040 and 1041 considerations, be less than 12 months. This allows for potential two other federal tax returns should be considered tax planning, as well as a prompt filing for an for the deceased. The first is Form 709 which estate that can quickly be closed. reports taxable gifts made during the year. In general, a gift to an individual of $15,000 or more Who pays taxes on the earnings of an estate? In is reported to the IRS. Such a gift may or may not some situations, it’s the estate itself. In other have an associated tax with it depending on situations, it’s one or more beneficiaries. several factors including the return is Form 706

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which reports assets of the deceased for, not • If you currently work with a CPA for your own income tax, but estate tax purposes. Only estates tax needs or if the deceased did so, this CPA over a certain threshold are subject to the federal may or may not be the best fit to help you estate tax. At the time of this writing, this amount is manage and close the estate from a tax over $11,000,000 in combined estate assets and perspective. If this person has done good work lifetime gifts. As such, most estates will not require for you or the deceased in the past, I a Form 706 filing to report and pay estate tax. recommend approaching them to see if working However, executors handling estates under this with estates is in their wheelhouse. If so, this is threshold should still give Form 706 consideration one less relationship you’ll need to develop for purposes of what’s known as portability. while administering the estate. If this type of Portability allows a deceased spouse to shift his or work isn’t something they feel comfortable her unused lifetime estate exemption to the handling, they may be able to provide a referral surviving spouse and is accomplished only by filing to a trusted colleague. If you don’t have a go-to a Form 706 to elect such treatment. If the CPA, ask for a referral from the attorney deceased has a surviving spouse or if the assisting you with closing out the estate. As deceased had a spouse whose executor had attorneys tend to work locally, you’ll likely be previously made a portability election, care should referred to a CPA local to the attorney, but know be taken in deciding the applicability of Form 706 that CPAs aren’t constrained by state to the situation. boundaries and can assist you regardless of the state in which you live, in which the deceased Also be aware of state-level taxes. States may tax lived, or in which the deceased had assets. the income of an estate via a state Form 1041 • I sometimes find that a consultation around tax equivalent, although this is generally handled concerns isn’t sought until after the estate without much fuss as part of the federal tax filing. administration process has begun, and What may not be as obvious is that some states sometimes not until the estate is ready to impose an estate tax on the estate and/or otherwise be closed. Although understandable, inheritance taxes on beneficiaries. The state estate this timing generally doesn’t provide any taxes may be on much lower thresholds meaning opportunity for tax planning. If possible, bring a that just because an estate isn’t subject to federal CPA onto your advisory team as early as estate tax doesn’t mean it isn’t subject to an estate possible to help determine what tax filings are tax to one or more states. Inheritance taxes are advisable and get them started. Time will be charged to the beneficiary rather than the estate needed to calculate the taxes that may be owed and can be an unpleasant surprise for an by the estate, time beneficiary distributions to uninformed recipient of estate assets. The good minimize taxes, coordinate an estate closing news is that few states impose such taxes, so it’s timeframe with your attorney, advise on IRAs quite possible these are of no concern to you. without beneficiary designations, and so on. When having an initial consultation with a CPA Working With A CPA about the estate, you may find everything is straightforward – you may even find that you With all the tax considerations of being an don’t need a CPA’s help at all. On the other executor, it’s a best practice to consult with a CPA hand, you may have a messy situation from a to determine the scope of the estate’s tax-related tax perspective, and it’s better to know and obligations. From there, you may find it helpful to address this as soon as possible. engage a CPA for any needed tax filings and tax- related advice as you administer and close the estate. A few thoughts on working with a CPA:

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• Keep good accounting records of estate activity. resolved. However, know that every year the You may already need these for court filings, estate is open, there could be tax but your CPA will also need them to identify consequences to the estate and its sources of taxable income and determine if any beneficiaries, as well as related tax return expenses are deductible on the deceased’s final preparation fees. income tax return or the estate’s income or • For certain types of assets in a deceased’s estate tax returns, etc. estate, the tax basis in these assets generally • Unless advised by an attorney to do otherwise, adjusts to the fair market value upon the don’t change brokers or close out bank deceased’s death. As such, consider having accounts too quickly. Once accounts are date-of-death appraisals prepared for those transferred, it’s much less likely you’ll be able to assets that will step-to market value upon death. obtain information if there are questions or to This may be a straightforward and inexpensive have tax documents corrected if there are proposition such as with residential real estate reporting errors. or it may require more time and expense such • In my practice, I find that some executors feel as with an interest in a closely-held business. comfortable preparing the deceased’s final • Consider filing Form 56 with the IRS as you 1040. This is usually the case when the begin administering an estate. This form informs executor is a child of the deceased and has the IRS that you are the estate’s fiduciary and been confidently assisting with mom or dad’s should receive any tax correspondence at your finances for a number of years. Most executors, mailing address. Form 56 is then filed a second however, feel more at ease having a time as the estate is closed and your fiduciary knowledgeable third-party handle the final duties are concluded. personal tax return. I rarely find that an executor • A few special situations that require further feels comfortable preparing other returns, e.g., analysis: 1041, 709, 706. As an executor, you are a o The deceased was not a US citizen fiduciary charged with the prudent management o The estate is insolvent of estate assets. It is entirely within your right to o The deceased or the estate owned obtain outside assistance with tax filing of the foreign assets or digital currency deceased and/or estate if doing so is in the estate’s best interest. While this is a primer on the tax Other Tax-Related implications for those administering an Considerations estate there is so much more that can • Executors and beneficiaries may be pursued for be said. This article should, however, a deceased’s income taxes or estate taxes not properly remitted. An executor who takes his or give executors an idea of what they’re her fiduciaries seriously and retains in for, but isn’t a substitute for knowledgeable legal and tax advisors will likely discussions with legal and tax not be overly concerned about this, but it is something of which to be aware. advisors. If I can help in any way or • There may be various and valid legal and tax answer additional questions, feel free reasons that an estate cannot quickly be closed, e.g., locating beneficiaries or planning around to contact me at [email protected]. IRAs. In this case, you have no choice but to leave the estate open until matters are

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