When your loved one dies, you can feel a deep sense of loss. You have family relationships to tend to. You have the funeral and figuring out what to do with the personal property and house. It can all feel overwhelming. We get it. But unfortunately, the IRS doesn’t care. The IRS won’t send a sympathy card. But they will start sending notices if the proper tax returns aren’t filed. That’s why dealing with death taxes (meaning any type of tax that’s owed after a person dies) is so important. Keep reading for a quick summary of the different types of taxes that need to be addressed.
Individual income tax returns may still need to be filed even for someone who has died. Federal and state income taxes, if any, are due on the income received by the deceased from the beginning of the year until the date of death. This income is reported on a federal income tax return, Form 1040. Any tax due on such income is a liability of the estate and is due on the April 15 following the year of death. If you are a surviving spouse, you can file a joint return with the deceased spouse even if he or she lived only one day of the year, as long as you have not remarried during the year.
If the deceased had been making quarterly estimated tax payments prior to death, future estimated tax payments are not required. The surviving spouse, however, is not relieved of making the future quarterly estimated tax payments on his or her income.
After death, a federal fiduciary income tax return, Form 1041, may have to be filed for each year the estate is open. This return reports the income received during the estate’s taxable year on probate assets. The estate is entitled to deductions against the income for administrative expenses not deducted on the estate tax return, Form 706 (see below). The estate may have a year-end that differs from the calendar year. An estate does not need to make quarterly estimated income tax payments for its first two years.
If the deceased was entitled to income but had not received it prior to death, it is called “income in respect of a deceased person (IRD).” This includes items such as the interest income portion of annuities, retirement plan distributions, and interest accrued on bonds. The persons inheriting that property (which may be you) should include the IRD income on their personal income tax return in the year they receive the property and pay income tax on that income amount. However, they may be able to take an itemized deduction for any federal estate tax (see below) paid on that income.
Federal Estate Tax
The federal government assesses a tax based on the value of the deceased’s estate. For tax purposes, the estate includes any property in which the deceased had an interest at death. The proceeds of a life insurance policy are also included in the estate. But, life insurance is not included if the deceased transferred ownership of the policy was more than three years prior to death. Life insurance is also not included in the estate if someone other than the deceased owned the policy. For inclusion in the taxable estate, it makes no difference how the deceased’s property passes to someone else. The property could transfer by will or without a will (intestacy). It could transfer by revocable living trust. It could transfer by community property agreement or by joint tenancy or other non-probate transfer. Regardless of how the property transfers, the estate includes any property in which the deceased had an interest at death.
In most cases, a federal estate tax return will have to be filed only if the total value of the deceased’s estate exceeds $12,060,000 for deaths in 2022 (the federal estate tax exemption). The federal estate tax exemption amount is currently scheduled to be adjusted annually for inflation. A tax return may be required, and tax may be due in certain other instances, such as if substantial gifts of property were made prior to death. In determining the amount of the estate for purposes of federal estate tax, only one-half of the community property is taxable for married couples, while all the deceased’s separate property is taxable. For example, no return is required, and no tax is due, in most cases, if there is no separate property and the total community property is valued under $24,120,000. This is because one-half of the value of the community property does not exceed the exempt amount of $12,060,000 and there is no separate property. If federal estate tax is due, it must be paid within nine months of the date of death. The filing of the estate tax return, but not the payment, can be extended six months from the nine-month filing date.
Deductions are taken against the value of the property for liabilities, such as mortgages, and for expenses, such as administration, funeral, attorneys, and accountants.
The estate tax rates on the part of the estate subject to tax (in excess of $12,060,000 after deductions) is 40 percent. If all the deceased’s property is left to the surviving spouse, no estate tax may be due because property passing to the surviving spouse may pass estate-tax free (but only if the surviving spouse is a U.S. citizen).
Even if no taxes are payable, most assets owned by the deceased get a new income tax cost basis for capital gains tax purposes, which is usually fair market value on the date of death. This can reduce, or even eliminate, capital gains on assets sold after death.
State Estate Tax
Arizona has no estate tax. No matter the size of your estate, you will not owe anything to the state. If your estate is worth enough, though, there’s a chance you could owe the federal estate tax. Plus, if the deceased person owned property in other states, there may be an estate tax on that property.
Other States’ Taxes
The deceased may have owned property located in other states or countries (such as a property in Iowa or Oregon, which also have estate taxes). Other states or countries may have estate or inheritance taxes, so you may face filing requirements and taxes due for those states or countries. Talk to a probate lawyer if you have a question about estate taxes. Click the link below to get help.
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Property taxes are due at the same time and in the same manner as if the deceased were still alive. After the transfer of property, the taxes are then paid by the person who receives the property, and the deceased’s estate has no further obligation.
Get Help with Death Taxes
This can all feel overwhelming. But you aren’t alone. Let us help you. Just click the link below to schedule a Strategy Session: