Tax Issues When Closing An Estate

When a loved one dies, the resulting tax issues must be handled.  The person to handle these issues is typically identified in the decedent’s will as executor of the estate.  However, if there is not a will, the probate court will appoint someone to be the administrator.

An executor’s job is to identify the estate’s assets, pay off its debts and then distribute whatever is left to the rightful heirs and beneficiaries.  He or she is also required to file any necessary tax returns and pay taxes.  If this is handled incorrectly, the IRS can come after the executor personally for tax underpayments.  Below are four major steps to be considered:

1. Filing the Final 1040.  The 1040 covers the period from Jan. 1 through the date of death.  If the decedent was unmarried, the final 1040 is prepared in the usual fashion.  When there is a surviving spouse, the final 1040 can be a joint return filed as if the decedent were still alive.  Also, look out for medical expenses, as large uninsured medical expenses must be treated differently for tax purposes. 
2. Filing the Estate’s Income-Tax Return.  Once the individual has died, any income generated by his or her holdings after death is now part of the estate and that income is subject to taxes. 
3. Filing the Estate Tax Return.  The federal estate tax return is filed on Form 706.  If the decedent did not make any sizable gifts before dying, no estate tax is due and no 706 form is required.  If sizable gifts were made, anything over $14,000 is added back to see if the estate tax exemption is surpassed. If so, then there will be a 40% federal estate tax on the excess. 
4. Miscellaneous Details.  If you’ll be filing Form 1041 and/or Form 706, you need to get the estate a federal employer identification number (EIN). Next, you should file Form 56 (Notice Concerning Fiduciary Relationship), which notifies the IRS that you’ll be acting on behalf of the estate regarding tax matters.  You should also open a checking account in the name of the estate with funds transferred from the decedent’s accounts.  The executor has the legal power to do this.

See Bill Bischoff, 4 Tax Issues to Consider When You Close an Estate, Market Watch, Feb. 17, 2015.

Special thanks to Jim Hillhouse (Professional Legal Marketing (PLM, Inc.)) for bringing this article to my attention.