Worried about inheritance tax? Read this if you are a beneficiary, executor, or trustee


This is the first part of a series on estates and taxes.

A loved one has passed away and you are an heir and possibly the executor or trustee of the estate. What is happening now for tax purposes? Good question. This is the first installment in our series covering the most important tax considerations for heirs when leaving a loved one.

If you are the executor

When a loved one (the deceased) dies, someone has to deal with the resulting tax issues. This person can be identified in the deceased’s will as the executor of the deceased’s estate. If there is no will, the probate court will appoint an administrator. In both cases, let’s call the person holding the bag the executor to keep it simple. That person can be you. If this is the case, please be careful, as you are responsible for filing the necessary tax returns and arranging to pay the taxes.

Or you can be the trustee of a trust that has been established to avoid probate. If so, you should also be careful.

The final form 1040

If your loved one was not married, the final form 1040 covers the period from January 1 to the date of death. The final declaration is prepared in the usual way. This is due to the standard date: 4/15/22 for someone who dies this year. You can extend the return for six months, until 10/17/22, by completing IRS Form 4868.

Year of death Form 1040 for surviving spouse

When there is a surviving spouse who remains single at the end of the year that includes the date of the deceased spouse’s death, a Final Spouse Form 1040 may be filed, as if the deceased spouse were still alive. The final joint return includes the income and deductions of the deceased spouse up to the time of death as well as the income and deductions of the surviving spouse for the entire year. Filing a joint return is generally beneficial, as it allows the surviving spouse to take advantage of the more beneficial rates and rules for taxpayers that apply to married couples filing jointly.

If the surviving spouse remarries on or before December 31 of the year that includes the date of the deceased spouse’s death, you should use the separate marriage declaration status for the deceased spouse’s final form 1040. The surviving spouse can file jointly with their new spouse.

Surviving spouse can use joint rates for two more years

The tax advantage of the status of married spouse declarer is extended to a widow or qualified widower for the two years following the year which includes the date of the death of the deceased spouse.

To be a qualified widower / widower for the year, you must be single at the end of that year. You must also pay more than half the cost of maintaining a house that is the primary residence for the entire year of one of your children (including a step-child) who is your responsibility for the year. (i.e. you paid more than half of his or her support). Finally, you must have been eligible to file a joint return with your deceased spouse for the year that included their date of death.

Revocable trust

To avoid probate, many individuals and married couples put in place means revocable trusts hold valuable assets, including real estate and financial accounts. These revocable trusts are often called living trusts Where family trusts. For federal income tax purposes, they are classified as grantor trusts. As long as the trust maintains revocable status, it is a grantor trust and its existence is not counted for federal income tax purposes. Therefore, the settlor, or settlers if the trust is for a married couple, are treated for tax purposes as if they still personally owned the trust assets. Thus, the grantor’s or grantor’s income tax returns are prepared in the usual manner without taking into account the revocable trust.

Revocable trust for deceased unmarried person

When a single person dies, their transferor’s trust becomes irrevocable. As such, the trust is now treated as a separate taxpayer subject to federal tax rules applicable to trusts. This is an unfavorable development, as tax rates on undistributed trust income rise rapidly to the maximum rate of 37% for ordinary income and short-term capital gains and to the maximum rate of 20% for long-term capital gains (LTCG) and eligible dividends.

If the 3.8% net investment income tax also applies, the marginal federal rate on investment income and retained earnings of a trust can be as high as 40.8% / 23.8%. Ouch! To avoid this fate, withdraw the income and gains from the trust by distributing them to the beneficiaries of the trust or by liquidating the trust.

Revocable trust of the married couple

When a revocable trust is created by a married couple, the trust generally continues to exist as a transferor trust after the death of the first spouse, with the surviving spouse taking over as the sole trustee. In such a case, the existence of the trust continues to be ignored for federal income tax purposes, and the surviving spouse’s Form 1040 is prepared in the usual manner without considering the revocable trust.

However, when the surviving spouse dies, the trust becomes an irrevocable trust. Then the trust is treated as a separate taxpayer with the adverse federal tax consequences mentioned above, unless you derive the income and gains from the trust by distributing them to the beneficiaries of the trust or by liquidating the trust.

The 2021 federal tax rate brackets for trusts are as follows:

Rate bands for ordinary income

10% tax bracket: $ 0 to $ 2,650
Start of 24%: $ 2,651
Start of 35%: $ 9,551
Start of 37%: $ 13,051

Rate bands for LTCG and dividends

0% tax bracket: $ 0 to $ 2,700
Start of 15%: $ 2,701
Start of 20%: $ 13,251

The bottom line

When an unmarried person dies, important federal tax considerations explained here apply.

When a married person dies, the surviving spouse can often be subject to relatively favorable federal tax rules, subject to timing considerations.

If you are the executor in either scenario, you are responsible for handling tax matters. So, you may want to hire a professional to prepare returns and help you implement tax saving strategies. You should probably also seek advice if you are the trustee of what is now an irrevocable trust that holds substantial assets. I’ll cover more tax issues for heirs in next week’s column. So please stay tuned.

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