Breaking Down Taxation of Deceased Estates

Breaking Down Taxation of Deceased Estates

Taxes are probably not the first thing you’ll think about when someone you love dies. It’s a heartbreaking event in our lives that we will never be able to handle easily. However, it is still important to bear in mind that your deceased loved one’s estate or the beneficiaries of that person’s trust has to deal with the taxes owed due to the person’s passing. To help you out, here is the following list of taxes owed by the deceased person on their estate or trust. We’ll also include the types of tax returns that need to be filed.

Federal Estate Taxes

You may have heard about federal estate taxes more than other taxes that are owed after someone’s passing. However, realistically speaking, the majority of estates will not have to pay federal estates taxes. This is due to the federal tax exemption passed in 2014 amounting to $5.34 million. The said exemption will also keep on getting higher starting January 1 of each following years considering the inflation. It is expected for the tax exemption to reach as much as $9 million per taxpayer by 2034 if inflation is set to an average rate. It is however mandatory for taxpayers owning estates with a value of $5.34 million or more to file a federal estate tax return using IRS Form 706, also called as the United States a Generation-Skipping Transfer Estate Tax Return.

If you’re a non-resident, your alien decedents must pay U.S federal estates taxes using IRS Form 706-NA also called as the United States Estate and Generation-Skipping Transfer Tax Return of nonresident (not a resident of the United States).

State Estate Taxes

If you’re among the lucky ones who didn’t have to worry about a federal estate tax return, then good for you! But there is still state estate taxes you have to think about too. If you’re a resident of the following states or a deceased person who owns real estate located in any of these states, you may have to pay state estate taxes:

  • Connecticut
  • Delaware
  • District of Columbia
  • Hawaii
  • Illinois
  • Maine
  • Maryland
  • Massachusetts
  • Minnesota
  • New Jersey
  • New York
  • Oregon
  • Rhode Island
  • Tennessee
  • Vermont
  • Washington

State Inheritance Taxes

The amount of estate tax you will pay is based on the total value of the deceased person’s estate. State Inheritance Taxes, on the other hand, is based on who inherits or receives the properties of the person who passed. There are only six states that are currently collecting state inheritance tax:

  • Iowa
  • Kentucky
  • Maryland
  • Nebraska
  • New Jersey
  • Pennsylvania

The good news about the state inheritance taxes charge by all six states is that the deceased person’s surviving spouse and charity will be exempted from it. Other states - Iowa, Kentucky, Maryland, and New Jersey also exempts properties passed by the deceased person to his descendants. In other words, chances of you paying state inheritance taxes are less likely to happen.

Gift Taxes

Most taxpayers overlook federal gift tax, therefore, results to tax consequences in the future. There are two states that collect gift tax at the state level:

  • Connecticut
  • Minnesota

Generally, an estate subject to federal estate taxes or state estates in Connecticut or Minnesota is required to file a gift tax return for the purpose of transparency on gifts that were made during the deceased person’s lifetime that wasn’t reported when the person was still alive. Filing for the federal gift tax return requires an IRS Form 709 also called as the United States Gift (and Generation-Skipping Transfer) Tax Return.

Generation-Skipping Transfer Taxes

The Generation-Skipping Transfer taxes also called GST taxes at the federal level is only applicable on estates that need to pay federal estate taxes where the estate is being passed to a “skip person” of when the estate is passed into a trust which is then called the generation-skipping trust. A “skip person” is a relative who’s age is two or more generations younger than the deceased person or to a person who not related in the family but is 37 and a half years or younger than the deceased person. Almost all states collecting their own separate state tax also takes care of a separate generation-skipping transfer tax.

Income Taxes

Filing the deceased person’s final income tax return at the federal level is not the only thing you need to do. Know that over the period of time while an estate or trust settled after the passing of the person, the estate or trust assets will be earning interest before the assets are distributed out of the estate or trust to their legal beneficiaries. Regardless of the step-up basis with certain types of assets owned by the deceased person, assets that are sold after death can still result in a capital gain from the sale.

Since tax laws change from time to time, it is best to consult a tax professional who will give you detailed information about the taxation of deceased estates as well as help you file your tax return faster and more efficient.

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