Post-death tax planning for the unprepared, Part 2: What are the personal representative’s responsibilities?
Tax filing requirements continue after a taxpayer’s death, and it’s the personal representative’s job to make sure those requirements are met.
Editor’s note: When a loved one dies unexpectedly, survivors face a potentially daunting task of settling the estate without a will. For the personal representative, completing the process requires several important tax-related duties. Part 1 of this series discussed how to identify the personal representative and the estate’s assets. In Part 2 of this series, we’ll discuss the personal representative’s ongoing responsibilities.
Recent events, such as disputes surrounding the estates of musicians Prince and David Bowie, show how the absence of an estate plan can lead to chaos. Disagreements can arise regarding:
- The total assets that the estate should include
- Who should oversee the distribution of these assets, and
- The identity and respective estate shares available to beneficiaries, among other things.
Following the guidelines of this article series can help avoid these pitfalls in estate planning.
Once survivors determine who should act as the personal representative (based on the criteria discussed in Part 1), the representative should obtain an identifying number for the estate, complete the decedent’s final returns, and determine any ongoing reporting requirements.
1. Obtain an identifying number for the estate and inform asset holders of the decedent’s death
After someone dies, payers often mistakenly report income decedents receive under the deceased person’s Social Security Number (SSN). This error can make it difficult to report the income correctly, because a return can’t be filed for a deceased person for any period after his or her death.
To prevent this error, the personal representative must first identify the deceased person’s assets, usually by reviewing the decedent’s financial records, including bank accounts and prior tax returns. A personal representative can request an IRS transcript for the decedent once the representative files Form 56. Then, if the estate will receive income from those assets, the estate must have its own identifying number so that payers can correctly report the income.
Apply for an Employer Identification Number on Form SS-4 or online
Estates need a nine-digit Employer Identification Number (EIN) for two reasons: Payers will report income paid to the estate under the EIN, and the estate will use the EIN to file required estate returns, just like individuals file their returns under their SSNs. To receive an EIN, the personal representative should file Form SS-4 or apply online.
When the personal representative notifies financial institutions holding the estate’s assets about the decedent’s death, the personal representative should also be prepared to provide the financial institutions with:
- The estate’s EIN
- A copy of the death certificate, if requested to confirm the decedent’s death
- The name of the estate
- The personal representative’s information (such as name, address, etc.)
How payers should report income from assets with beneficiaries versus without beneficiaries
Not all assets will become part of the estate for income tax purposes. For example, assets that already have a named beneficiary (such as a bank account with a transfer-on-death designation or assets held in a trust) will transfer directly to that beneficiary. These assets pass outside of the estate and are called non-probate assets, while the estate’s assets are probate assets.
The income tax reporting rules are different if the asset has a designated beneficiary and is a non-probate asset. In those cases, payers will report any post-death income related to the asset directly to that beneficiary using his or her SSN, rather than using the estate’s EIN. With these non-probate assets, the person who must inform the payer of the decedent’s death will vary. With a trust, for instance, the trustee named in the trust agreement would need to take on this responsibility.
Probate assets, on the other hand, report income directly to the estate under the estate’s EIN. The personal representative will include this income on the estate’s income tax return (Form 1041).
2. File the decedent’s income tax returns
In addition to these potential post-death reporting requirements, the personal representative must complete and file the decedent’s unfiled personal income tax returns.
In most cases, this duty only involves filing the decedent’s final return, but it can apply to other years, as well. The personal representative must file all required individual returns for the decedent. This is important to remember if the decedent failed to file for any past years. That’s because there’s no time limit for the IRS to assess taxes related to those returns. Also, the personal representative should keep a copy of the decedent’s death certificate, but doesn’t have to attach a copy to the decedent’s final return.
Gather tax records and pay any outstanding debts first
To file a complete and accurate return, it’s a good idea for the personal representative to request the decedent’s prior-year returns and tax records using Form 56, as discussed in Part 1. These records are useful when trying to identify the decedent’s income-producing assets, as well as whether the decedent met prior filing requirements.
Executors, administrators, or any person who holds a “material interest” in a decedent’s return can request various types of tax transcripts using Form 4506-T. In general, any beneficiary will have a material interest in the decedent’s income tax records, but whether an interest is material is ultimately up to the IRS.
The personal representative should first use the estate’s assets to pay any prior-year tax balances the decedent owed. Then, the representative should distribute remaining assets to the beneficiaries. Otherwise, the IRS may hold the personal representative personally liable for any taxes owed.
Because of the potential personal liability for the personal representative, it is vital to identify all the decedent’s outstanding debts before distributing estate assets. This may also include non-tax debts. Some common examples of non-tax debts include mortgages, credit card debts, and medical debts. If the estate can’t pay all the outstanding tax debts, and the personal representative doesn’t make any distributions to the beneficiaries, then the personal representative isn’t personally liable for the remaining unpaid amount.
3. Determine any ongoing estate transfer tax and income tax filing requirements
In addition to the income tax filing requirements, in certain cases there may be other estate and gift tax filing requirements. These filing requirements involve a separate set of tax forms, rules, and penalties. Nonetheless, for most of us who are not international music superstars, these filing requirements will not apply to our estates.
File Form 706 for larger estates with a value of more than $5.49 million or a surviving spouse
In some situations, an executor must file a federal estate tax return using Form 706. In situations where there is no estate plan and no court appointment, it is likely that the personal representative will also act as executor. However, most taxpayers, especially those without an estate plan in place at death, won’t need to file this return since the filing thresholds (based on the amount of assets in the gross estate) are relatively high.
For 2017, an executor must file Form 706 if:
- The gross value of the estate’s assets, including all assets owned by the deceased at the time of his or her death, is more than the estate tax exclusion amount of $5.49 million (minus lifetime taxable gifts), or
- A surviving spouse wants to elect to use the deceased spouse’s unused exclusion amount (the portability election).
The gross value of an estate includes both probate and non-probate assets.
Note that states may also have their own estate or inheritance tax filing requirements that differ from the federal rules. For example, Massachusetts uses a lower state estate-tax filing threshold of $1 million.
File Form 1041 if the estate receives more than $600 in gross income
Even if the estate doesn’t have a Form 706 filing requirement, the personal representative will need to file an income tax return for the probate estate using Form 1041 if it receives $600 or more in gross income during the year. The form reports income earned on assets held in the deceased person’s probate estate, even if the estate isn’t subject to a state-level probate process. This is the income that is reported to the estate’s EIN. This filing requirement applies every year until the estate terminates, which usually occurs when all of the probate assets have been distributed.
File Form 709 to report any taxable gifts made by the deceased person
The personal representative must report the deceased person’s taxable gifts using Form 709, including prior-year unfiled returns. Most gifts should not result in actual gift tax liability owed, but a decedent who made taxable gifts will have a lower exclusion available to his or her estate. This is because estate and gift tax exclusion amounts are tied together; lifetime taxable gifts are not taxed to the extent of the exclusion amount ($5.49 million in 2017), but they are applied against the limit. The more taxable gifts given by a decedent, the lower the estate income exclusion.
In Part 3 of this series, we will discuss what types of income are reported on Form 1041, and how to determine when the estate can terminate. We will also cover the tax consequences for estate beneficiaries who receive inherited assets and income from those assets.