Tax Implications at Death
What are the tax implications of a loved one’s death? If you are the executor, trustee or personal representative of an estate, you will be responsible for timely filing certain tax returns on behalf of the decedent. This includes a final Form-1040 for the last year the decedent was alive. You may also need to file Form-1041 for each year the estate and/or trust is open. Finally, depending on the size of the estate and what assets are involved, you might also need to file a 706 Estate Tax Return within nine months of death. Make sure you have a good accountant or attorney who can help you navigate this system as it can be quite complex and overwhelming!
The Federal Estate Tax
Although there is a Federal Estate Tax, it only applies to a decedent whose gross estate at date of death totals more than $13,610,000 (or doubled if married) in 2024.* What counts as part of the estate? Anything that the decedent owned! This includes, but is not limited to real estate, stocks, bonds, cash, mineral and gas rights, life insurance, IRA’s, annuities, vehicles, cryptocurrency and tangible personal property. The Federal Estate Tax only applies to the top percentage of individual estates. However, a wise fiduciary might choose to file Form 706 within nine months of the decedent’s death for several reasons. First, most assets will take the stepped-up basis.** For example, if the decedent purchased a house in 1950 for $30,000 and that house in 2023 is now worth $700,000, then whoever inherits the house will want that stepped-up basis of $700,000 to avoid capital gains. Second, we never know when the Federal Estate Tax will change in the future, so by timely filing the form, even when no tax is due, it ensures that a surviving spouse can make a portability election to use the deceased spouse’s exemption for themselves down the road.
But, after all deductions have been taken (examples of deductions include gifts to spouse, gifts to charities and costs of estate administration), the decedent’s estate still totals more than $13,610,000, the tax rate is a whopping 40% of the excess. There are certain tax savings devices that can be created to prevent the government from taking that 40% of the excess. It is so important to consult an attorney and accountant when thinking of such tax consequences. You do not want to leave a deduction on the table or forget to report something. Even if an estate is not taxable at the federal level, it may be taxable at the state level and certain states require the filing of Form 706, even if there is no tax due!
*There are proposals to eliminate and/or lower the Federal Estate Tax, so we will have to wait and see what Congress does.
**The Biden administration has proposed a major wealth tax proposal on capital gains including eliminating the stepped up basis treatment. If new tax laws are enacted, it is worth re-visiting your estate plan to maximize your tax savings.
Inheritance Taxes
Inheritance taxes are passed to the beneficiaries of an estate or trust. Although there is no federal inheritance tax, some states do impose an inheritance tax on the beneficiaries, based on your relationship to the decedent (ie. spouses probably won’t have an inheritance tax, but a third cousin once removed could have one) which will differ from state to state. States like Virginia have no estate or inheritance tax. Check with your lawyer or accountant to determine what forms will need to be filed.
Gift Taxes
In 2024, an individual may gift up to $18,000.00 per person, per year tax free. The gift reduces future estate taxes, does not create a gift tax and is income tax free to the recipients. A gift tax return is not needed if the annual gift per person is less than this amount. Each year, anything over the gift tax threshold needs to be reported on a Form 709. However, you are not taxed on the gift unless you have given in your lifetime the threshold of the estate tax exemption (currently $13.61 million in 2024). Form 709 is how the lifetime gifts are tracked by the IRS, and a fiduciary might be responsible for filing these for a Decedent.
The Takeaway
Tax returns can be increasingly complex. Don’t jump into it without assistance and leave the preparation of these to a professional. Contact us to set up your initial consultation!
