From The Portsmouth Herald, April 10, 2011
Money Talk: Death and taxes: Income reporting when a loved-one dies
By David T. Mayes, MA, EA, CRPC(R), CFP(R)
When a loved-one dies, a family member is often called upon to settle his or her affairs, not the least of which is filing the decedent's final income tax returns. Although death and taxes are both certainties, the responsibility to report income received during the year does not end at death. For survivors, handling these filings, in addition to their own, can make tax season especially challenging.
A frequent question of survivors who receive assets from a loved-one is who pays the taxes on the money? Many recipients of lump-sums from a relative fear a large tax bill as a result of the inheritance. This, however, is usually not the case as only the income the survivor receives as a result of the inheritance is reportable on his or her personal income tax return. The value of the assets received is not income, and will only generate taxable income if the assets are sold at a gain in the future.
When confronted with the job of preparing a final return for a deceased taxpayer, it is important to remember that only the income earned between the beginning of the year and the date of death should appear on the final return. Income received after death, however, is still taxable and must be reported somewhere, either by a beneficiary or on an estate or trust tax return. This is where things can get very complicated, particularly when there are delays in transferring accounts to their new owners.
Consider a taxpayer with a sizeable brokerage account who dies on January 15th. Only interest and dividends paid prior to this date will be reportable on his final tax return. After his death, the executor of his estate must contact the account custodian to change the ownership. Assuming there is no joint owner or beneficiary named on the account, the new owner becomes the deceased's estate. The estate is a separate taxpayer with its own tax identification number which must then file its own tax return to report interest and dividends received after the date of death and before the final distribution of the assets to the decedent's heirs.
The difficulty for the executor in preparing the tax returns is that the brokerage firm holding the account will issue a 1099 form reporting income to the IRS that will likely capture more income than was actually received prior to the date of death. If the executor does not change the account ownership to the estate until April 15th, the 1099 issued under the decedent's social security number will show too much income and the 1099 for the estate too little. To correct this, the entire amount of income shown on the decedent's 1099 should be reported on his return, with a deduction taken for the income being reported on the estate's return.
To offset the decedent's income, all deductible expenses paid before death should also be reflected on his final return. For medical bills there is a special exception which allows for bills paid within one year of death to be treated as being paid when the expenses were incurred. Medical expenses are still taken as an itemized deduction to the extent that they exceed 7.5% of adjusted gross income. For taxpayers who do not itemize deductions, the full standard deduction is available, even if death occurred early in the year.
Surviving spouses will likely benefit from filing a joint return for the year of death because this allows use of both personal exemptions and takes advantage of the lower joint return brackets. Spouses can continue to take advantage of joint return tax rates for two years following their husband's or wife's death by filing as a qualifying widow or widower.
If the decedent is due a refund and there is no surviving spouse, the personal representative will need to file Form 1310 before the IRS will release a payment. For additional information on filing this form and other tax filings for decedents, their estates or trusts, please see IRS Publication 559 which is available for free at www.irs.gov.
David T. Mayes is a CERTIFIED FINANCIAL PLANNERTM professional and IRS Enrolled Agent at Mackensen & Company, Inc., a fee-only advisory firm in Hampton. He can be reached at (603) 926-1775, david.mayes@mackensen.com or by visiting www.mackensen.com.