Did the Decedent Own Capital Assets?

If the decedent owned capital assets, the fair market value (FMV) of those assets at the time of death must be determined for estate and probate purposes and for determining the basis of the assets in the hands of the beneficiary.

FMV is determined as of date of death (or an alternate valuation date in some cases when an estate tax return is required). This means that if the heirs sell inherited property soon after the decedent's death, the result will usually be little or no gain. FMV will be used to figure depreciation, as well as for figuring gain or loss on sale.

Valuation of inherited property is generally taken from the estate tax return (if any) unless the taxpayer (heir) can prove a different value. If there is no estate tax return, probate papers may provide an "inventory" showing values of items in the estate. If no probate is required, for example because all of the decedent's assets were held in a living trust, the trustee of the trust may have compiled a list of the property and their values and should be able to provide the information to the beneficiaries. 

CAUTION: For assets inherited from decedents who died during 2010, the beneficiaries' basis will depend on whether the estate was subject to the estate tax or elected out of the tax and chose instead for the beneficiaries' basis to be determined under the modified carryover basis regime.  Regardless of which method the executor selects—estate tax with stepped up basis for the assets or the modified carryover basis—a beneficiary should contact the executor for information as to the basis of assets that he or she inherits.
  • Stocks, mutual funds and other readily traded securities: The FMV of an inherited stock is the average of the high and low prices quoted for the stock on the valuation date (generally the date of death). If the date of death is a weekend or holiday, additional calculations are required.  The stock listings for the date of death from a newspaper will provide the high/low information for most stocks or it can be found on various internet web sites. The fair market value of inherited mutual funds generally is the last quoted public redemption price on the date of death. For more complicated portfolios, contact the brokerage firm and request a listing of all securities held by the decedent along with the high and low quotes (or closing price if that's all it can provide) on the date of death. 

  • Real Property: Depending upon state law, for estate tax and probate purposes, real property generally must be appraised by a qualified appraiser. However, if there is no requirement for probate or estate tax filing, then the executor or heirs will need to establish the FMV through other means such as a qualified appraiser or comparable sales. 

The valuation process can be complicated, and it may be to your benefit to consult with this office as soon as possible for assistance.

Is a Fiduciary Return Required?

Generally, income attributable to a decedent up to the time of death is included in the decedent's final individual tax return. Upon death, income that would have been attributable to the decedent is now income to the decedent's estate and reported on the estate's income tax return.

Form 1041 (fiduciary tax return) is the income tax return used for the estate. It is used to report income on the assets in the estate, including sales of property. The estate exists until final distribution of its assets. The tax year can be a calendar year or a fiscal year--the type of year is chosen when the first 1041 is filed for the estate. Once chosen, the tax year can only be changed with IRS permission.

Filing requirement
- A return must be filed if the estate has gross income of $600 or more. However, if one or more beneficiaries are a nonresident alien, Form 1041 must be filed even if the gross income is less than $600.

K-1s – Schedule K-1s are filed with the 1041 for each beneficiary. A copy of the K-1 must be furnished to each beneficiary. The K-1 shows the allocation of the beneficiary’s share of the estate’s income and losses that the beneficiary will need to report on his or her income tax return.

Because of the complexity of fiduciary returns, you should contact this office for your preparation needs.

Final Return of the Decedent

Generally, the same filing requirements apply to a deceased taxpayer as would otherwise be used if the taxpayer were still living, based on income level, age, and filing status. CAUTION: A fiduciary return reporting the income earned on the decedent’s assets after the date of death and until the assets are distributed to the beneficiaries may also be required. In many cases, a fiduciary return may need to be filed for more than one year.

Refunds
- If a decedent's return claims a refund, Form 1310, Statement of Person Claiming Refund Due a Deceased Taxpayer, should be filed. However, Form 1310 is not needed if:
  • The person claiming the refund is the surviving spouse of the decedent, filing a joint return with the decedent, or

  • A court-appointed or certified personal representative is filing an original return for the decedent.

Income to Include - The decedent's income on the final return generally includes income derived up to the date of death. 

Exemptions and Deductions - The general rules for exemptions and deductions apply to the final return. 

  • Medical Expenses: Medical expenses paid before death are claimed by the decedent as itemized deductions in the usual manner. Medical expenses not deductible on the final return become liabilities of the estate--they are claimed on the estate tax return. However, expenses that were paid out of estate funds within one year after death can be treated as if paid by the decedent and claimed on the decedent's final return instead of on the estate return. 

  • Net Operating Loss (NOL) Carryovers: An NOL carryover of the decedent can only be deducted on his/her final return. If the final return results in an NOL, it can be carried back to the decedent's prior year returns (just as with other NOLs). 

  • Passive Losses: When a passive interest, such as a rental property or limited partnership interest, is transferred due to death, the accumulated suspended losses from the activity are deductible on the decedent's final return. The deduction amount is limited to the excess of the basis of the property at date of death over the decedent's adjusted basis in the property just before death.


Other Tax Attributes
– What becomes of other tax carryovers attributable to the taxpayer upon his or her death? To the extent that the following carryovers are attributable to the taxpayer (in the case of a married taxpayer all or half of the carryover on a joint return may be attributable to the surviving spouse), the balance of the following carryovers are lost.

  • Charitable Contribution Carryover
  • Investment Interest Carryover
  • Capital Loss Carryover
  • Business Tax Credit Carryover
  • Minimum Tax Credit Carryover

Special rules apply to the carryovers of foreign tax credit, domestic production deduction and unrecovered basis in the decedent’s pension. In addition, any unsatisfied term of the moving deduction qualification period is waived. 

Return Signature, Etc.
 - The word "DECEASED," the decedent's name and the date of death should be written at the top of page one of Form 1040. If there is a personal representative, that person must sign the return. If the return’s filing status is married joint, the surviving spouse must also sign. If there isn't a representative and the return is being filed jointly, the surviving spouse signs the return and notes in the signature area: "Filing as surviving spouse". If the decedent had no representative or wasn't married, the person in charge of the decedent's property should sign as "personal representative."

Due Date - Due date for the decedent's return is the same as for any other taxpayer, regardless of the date of death during the year.

Returns That Need To Be Filed

The following are the basic returns that may need to be filed following a taxpayer's death, dependent on the filing requirements of each:

Form 1040
- File the decedent's final federal return as usual on Form 1040, 1040A, etc., and a corresponding state return, if required.

Form 1041 - This is the federal income tax return of the estate--used to report income received on the assets in the estate, including sales of property. An equivalent return for the decedent’s state of residence may also be required.

Form 706 - Used to compute the tax on the value of the assets in the estate and is required if the gross estate is greater than the taxpayer's estate tax exemption. Unless reduced because of pre-death gifts, the federal estate tax exemption is $5.54 million in 2016 ($5.49 million in 2017).

Effective for deaths of married individuals occurring after 2010, by election, if all of the decedent’s estate tax exemption is not used, the excess can carry over to the surviving spouse to be added to his or her own exemption when the time comes. The election must be made on the estate tax return of the first spouse to die. Therefore, even if the value of that deceased spouse’s estate is less than the 706 filing requirement it will be necessary to file a Form 706 to make the election.

CAUTION: Some may consider not filing the 706 to avoid the trouble and cost when the estate value of the first spouse to die is below the filing requirement and there is not a foreseeable need for the carryover for the surviving spouse. That choice should be considered carefully since future inheritances, lotto winnings, inflation, tax law changes and other events could make the surviving spouse’s estate subject to unexpected inheritance tax.

A state estate tax return may also be required, depending on the decedent’s state of residency and that state’s filing requirements; many states do not have an estate tax or piggy-back on the federal return

Please contact this office for return preparation assistance.

Was Decedent Receiving Social Security Benefits?

If the answer to that question is "yes," a family member or other person responsible for the beneficiary's affairs should do the following:
  • Promptly notify Social Security of the beneficiary's death by calling Social Security Administration toll-free at 1-800-772-1213. Note: Some funeral homes will automatically inform the Social Security Administration as part of the services they provide. Check with them prior to contacting the Social Security Administration.

  • If monthly benefits were being paid via direct deposit, notify the bank or other financial institution of the beneficiary's death. Request that any funds received for the month of death and later be returned to Social Security as soon as possible.
A lump sum may be payable to the surviving spouse if he or she was living with the beneficiary at the time of death, OR if living apart, was receiving Social Security benefits on the beneficiary's earnings record. If there is no surviving spouse, the payment is made to a child who was eligible for benefits on the beneficiary's earnings record in the month of death.

Surviving Spouse Remarries in Same Year

If a deceased taxpayer was married at the time of death, the executor of the estate of the deceased taxpayer will have two filing options for the decedent:
  • File a joint return with the surviving spouse, or
  • File as a married taxpayer filing a separate return. 

If the surviving spouse remarries before the end of the tax year, the return for the deceased spouse is required to be filed as married separate, and the surviving spouse can either file jointly with the new spouse or married separate.

Selecting the most advantageous filing status can have a significant impact on the overall tax liability. Please call this office for assistance.

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