Posted by Abundant Wealth Planning LLC

Understanding The Basics of Estate Income Tax After The Death of a Loved One

Understanding The Basics of Estate Income Tax After The Death of a Loved One

There are many changes after the death of a loved one, including changes in tax obligations. Unfortunately, it's easy to be overwhelmed by these changes. There are new reporting requirements, various taxes that may come into play, new obligations for beneficiaries, and new concepts that most people don't come across regularly. While every estate and trust has its issues, knowing the basics can help you navigate these changes more easily.


The person responsible for the management of an estate or a trust

There are different roles and titles for the person who manages the estate of a deceased person. For example, suppose probate has been opened in court to manage a person's estate in their own name. In that case, the responsible person is usually appointed as the personal representative or executor of the estate. However, if the deceased person created a trust during their lifetime or at the time of their death, the person who manages the trust assets is appointed as the administrator. Thus, the administrator is a common term used to describe the person responsible for filing a tax return for a trust or an estate.


Final individual income tax declaration 

A final individual income tax return, Form 1040, usually has to be filed when a person dies. This is the same return filed each year, except the fiscal year covering the entire calendar year, which covers January 1 until the death of the person. All income of the deceased during this period is declared in the final income tax return. Additional forms, such as Form 1310 may be needed to claim a refund owed to the deceased taxpayer.


Estate tax declarations

If a deceased person had individual income-generating assets, such as a savings account or brokerage account, those assets would likely have to go through the inheritance process. The deceased person's estate becomes their own taxpayer, with the taxpayer's identification number and tax reporting obligations.

The estate income tax is often confused with the estate tax, but they are two separate taxes. Estate income tax is a tax levied on the income generated by the real estate during the fiscal year. You must file a tax return for each tax year in which the property generates income above the reporting threshold, with a final tax return for the tax year in which the estate closes. An estate tax is a one-time tax on the value of property owned by the deceased and is usually paid nine months after the deceased's death.

Farms can choose between two tax reporting periods, the calendar year or the fiscal year. For calendar years, the first calendar year of the estate is the remainder of the year following the person's death. For example, if a person dies on November 5, the last personal income tax return is filed between January 1 and November 5. Thus, the first calendar year for the estate is between November 6 and December 31. Each year thereafter, the tax year on real estate income runs from January 1 to December 31.

The fiscal year begins on the date of the deceased's death and ends in the month preceding the first anniversary of the date of death. For example, if a person dies on November 5, the fiscal year will end on October 31 of the following year.

Both calendar and fiscal year have advantages and disadvantages. As with individual returns, the annual inventory runs from January 1 to December 31, so it's easy to remember when to file. However, if an estate has been open for more than a calendar year, you may need to file for several years. On the contrary, because the fiscal year is always 12 months, the estate may be closed with fewer returns. The fiscal year returns may also defer the payment of income tax for a longer period.


Trust Income Tax Returns

In addition to or in place of an inheritance tax return, a trust tax return may be required for any trust created during the deceased's lifetime or after the person's death. When an individual creates a revocable trust, that trust generally does not have to file an income tax return during the taxpayer's lifetime for income from assets held by the trust. Instead, the trust is considered a "disregarded entity," The income is reported on the taxpayer's income tax return.

Most trusts become irrevocable after the taxpayer's death and cannot be exchanged unless special circumstances exist. The trust becomes its taxpayer and must file the trust's annual income tax return when it generates income above the filing threshold. Typically, the trust must file its return in a calendar year. However, in many cases, you can choose to include trust income on your tax return. Therefore, the trust can have a fiscal year if the property makes this choice.


Estate and Trust Tax Rates

The federal government taxes estates and trusts at much more aggressive rates than individuals. For example, in 2021, estate and trusts are taxed at 37% taxable income over $13,500. 

Like the standard deduction for individuals, estates and trusts benefit from an income exemption, reducing the tax burden. However, this figure is significantly lower than that of individuals, ranging between $100 and $600, depending on various factors.

Estates and Trusts are also eligible for income deductions. Regular deductions include legal and accounting fees. They can also benefit from deductions for income distributed to the beneficiaries of the estate or trust. This may include distributions made after year-end if appropriate choices are made. The income is then reported in the recipient's income tax return and taxed at the individual's tax rate.


Other fiduciary duties relating to estates and income taxes

The responsibilities of a trustee are not limited to filing appropriate income tax returns and distributions to beneficiaries. The administrator may have several additional responsibilities which are not immediately apparent. For example, the fiduciary may be required to submit an accounting, which is a record that typically includes information about the assets, income, and expenses of an estate or trust. Accounting is generally an annual requirement and may be required by the state, local, a trust, or a will.


Get professional help

Professional assistance can help alleviate concerns about tax obligations and requirements relating to estate and trust.

  • Ensure the trust or estate is reporting income correctly, making the proper deductions, and making timely elections.

  • Prepare real estate or trust accounts that meet the fiduciary's obligations to beneficiaries.

  • Submit correct returns and fill-in forms promptly.


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