Death and taxes are both inevitable. Even though neither are pleasant, we’re going to discuss how they intersect. Read on to see how death impacts your taxes - and the taxes of your loved ones.
Final Tax Return
Death doesn’t stop Uncle Sam from collecting what’s due to him. When you die, a final tax return must be submitted by the tax deadline of the following year. Here are the main points to be aware of:
Your estate executor or surviving spouse will typically file your final tax return. If neither is in place, the court will name someone to take on the task. If your executor files, they’ll sign on your behalf.
If your surviving spouse files, they must write in “filing as a surviving spouse” on the return. They can still file jointly for this return to take advantage of the married filing jointly standard deduction and tax rates. They may also be able to file as a qualifying widow(er) for up to two years after your death, subject to several rules and regulations.
Any income you earned before your death must be reported on your final tax return. If your estate earns more than $600 of income (usually through investment interest or dividends), your executor must file Internal Revenue Service (IRS) Form 1041 (U.S. Income Tax Return for Estates and Trusts). The estate itself won’t pay taxes on this income, however. When the income-producing assets are doled out to your designated beneficiaries, they’ll be liable for any tax due.
Whoever files your final tax return can claim your full standard deduction, no matter what day you died during the year. If they itemize, they can write off any expenses you incurred before your death. They can also deduct your medical expenses paid within one year of your death, which can help if you racked up a lot of hospital bills at the end of your life.
Tax Owed or Refund Due
If you owe tax, your estate will have to pay the IRS. But, if you’re due a refund, your executor must file IRS Form 1310 (Statement of Person Claiming Refund Due a Deceased Tax Payer) with your final tax return. They’ll receive the refund on your behalf.
If you leave a retirement account to an heir, they’re going to face tax implications based on their relationship to you and the type of account that you leave for them. A 401(k) and a traditional individual retirement account (IRA) are treated much differently than a Roth IRA. So, be sure that you name beneficiaries for each account you have, and learn about what happens to the funds when you die.
When you bequeath an asset to a loved one, they’re only responsible for paying the tax on gains realized after your death. That means if you leave them a stock that went up by $100 a share while you were alive but increased by just $1 after you died, they’d only have to pay tax on that $1 profit when they sell. Also, if your surviving spouse sells your home within two years of your death, they can avoid paying capital gains tax on up to $500,000 of profit. (Normally, $250,000 would be exempt.)
The estate tax, known as the death tax, is assessed based on the value of your estate, or collective assets. Fortunately, most estates are exempt.
Federal Estate Tax
The federal estate tax only applies if your assets are worth more than $11.58 million. If that’s the case, your executor must file IRS Form 706 (U.S. Estate (and Generation-Skipping Transfer) Tax Return). Since most estates are worth far less, your heirs likely won’t have to worry about it.
Deep Dive: If your estate is subject to the federal estate tax and bequeaths assets to heirs more than 37.5 years younger than you, the Generation-Skipping Transfer Tax (GSTT) may apply.
State Estate Tax
Washington, D.C., and the following states impose an estate tax: Connecticut, Hawaii, Illinois, Maine, Maryland, Massachusetts, Minnesota, New York, Oregon, Rhode Island, Vermont, and Washington. Every state has its own laws regarding estate value and how to file. So, if you lived in or owned property in one of these states, your executor should check with that jurisdiction.
The estate tax focuses on the value of your collective assets and is paid by your estate. The inheritance tax is based on what your individual heirs receive from the estate and is paid by each beneficiary. Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania charge an inheritance tax. The good news? Your surviving spouse and named charities are exempt.
How Rapidly Can Help
Dealing with taxes can be complicated at the best of times. But, when you add in grief and a staggering to-do list, that burden may feel impossible for your loved ones. Rapidly can help. We’re an easy-to-use online platform that connects taxpayers with a tax professional who will quickly, smoothly, and accurately get them through this difficult period. Check us out for free!
When you die, it’s an emotionally challenging time for your loved ones. Financial matters are understandably not a top priority. However, it’s essential for you and for them to understand how death impacts your taxes. We encourage you to seek the help of a qualified tax professional and estate attorney to set your estate up in the most tax-advantaged way. Then, give their contact information to your executor.