When someone passes away, their tax headaches don’t die with them.
In fact, those obligations can further complicate the lives of survivors: Federal estate taxes may be due and state inheritance taxes could come into play as well.
“You still have to reconcile tax liabilities in the year of death when you had income,” says Mark Steber, Chief Tax Information Officer at Jackson Hewitt. “Sooner or later someone will have to clean it up, and it usually falls to a family member.”
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Melissa Burgess is one of those people. When her father passed away suddenly in early 2018, she filed his 2017 return while a lawyer helped file his 2018 return through her father’s estate.
But Burgess, who lives in Buffalo, New York, is still waiting on her father’s 2017 tax refund from the IRS. And the pandemic has made it even more challenging for her and her sister to get in contact with the agency since it has been overwhelmed by sweeping tax code changes even as it sends stimulus checks to millions.
“It’s been very frustrating,” says Burgess, 30, who is a clerk at a local library. “If the pandemic hadn’t happened, then maybe things would be resolved by now.”
Adding to her frustrations, the IRS also mistakenly sent a $1,200 stimulus check to her dead father last spring that she had to send back, she says.
“This is the last piece of the puzzle for my father’s estate. How am I still having to deal with this three years later? My dad is owed this money. I’m not going to give up until I get it.”
The filing of the deceased taxpayer’s final return typically falls to the executor or administrator of the estate. If neither is named, then it’s taken over by a survivor of the deceased, according to Lisa Greene-Lewis, a CPA at TurboTax.
“This likely impacted many families in 2020 due to the pandemic,” Greene-Lewis says.
Those survivors are not only stressed about complicated tax paperwork, but they’re also in mourning.
“The final year of a tax return is a sensitive topic because you’re dealing with emotions and fragile feelings,” says Steber, who says family members who are suddenly responsible for their loved ones’ taxes shouldn’t go it alone. “When the time comes, get experienced help.
The final return is filed on IRS Form 1040, the same one that would have been used if the taxpayer were alive. The difference is that “deceased” is written after the taxpayer’s name, Greene-Lewis says.
If the taxpayer was married, the widow or widower may file a joint return for the year of death. For the two years following a person’s death, the surviving spouse can file as a qualifying widow or widower, which would allow them to continue to use the same tax brackets that apply to married-filing-jointly returns.
The bigger the estate and the larger the income is for a decedent, the more complex the situation will likely become, which creates a greater need for a tax professional, Steber says.
“Make this a part of your will and put an executor in charge,” Steber advises.
The estate tax, for instance, is charged on a person’s assets when they die. A 40% federal estate tax applies to estate values that exceed $11.7 million, or $23.4 million per married couple, though fewer than 2,000 households are expected to pay estate taxes for last year, according to the Tax Policy Center.
The Biden administration is expected to propose a lower estate tax exemption, which would subject more estates to tax after a death. Biden has called for lowering the exemption to $3.5 million for estates.
Eric Pierre, founder, CEO and principal of Pierre Accounting, says his firm has received an increase in estate planning this year.
“The pandemic has gotten people’s attention. Anyone can die at a moment’s notice. But now that people are dying of COVID, I think it really woke them up about that reality to make sure they have a plan in place.”
Distinguishing between who needs an estate versus who needs a simple will depends on individual circumstances, Pierre adds. For those who own real estate or substantive assets, they should have an estate, he recommends.
The deadline to file a final return is the tax filing deadline of the year following the taxpayer’s death, which would be May 17 for 2020 returns after the IRS extended the deadline this tax season.
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If an executor or administrator is involved, he or she must sign the return for the decedent. When a joint return is filed, the spouse must also sign.
When there isn’t an executor or administrator, whoever is responsible for filing the return should sign the return and note that he or she is signing “on behalf of the decedent.”
If a joint return is filed by the surviving spouse alone, he or she should sign the return and write “filing as surviving spouse” in the space for the other spouse’s signature.
There’s one more step if a refund is due.
If the decedent is owed the money, it can be claimed using IRS Form 1310, Statement of a Person Claiming Refund Due a Deceased Taxpayer, according to Greene-Lewis.
Although the IRS says that surviving spouses filing a joint return don’t have to file with this form, tax experts suggest it’s still a good idea to include to head off possible delays.
The refund, if it is solely in the name of the decedent, will be distributed to heirs or beneficiaries, according to Pierre. If the decedent has a surviving spouse, they can get the refund on a married filing joint return.
If a decedent owes taxes, the tax bill is supposed to be settled by the decedent’s estate’s executor, says Pierre.
In the event that the decedent has insufficient funds to cover the federal income and estate taxes, the relatives aren’t responsible for the remaining balance, Pierre adds.
The executor of the estate can be held liable if the executor distributes assets to heirs and beneficiaries before paying the taxes, or if the executor pays off other debts of the estate before paying the tax liabilities, or if the executive is aware of the insufficient funds and inability to pay the taxes but spends the assets otherwise, he says.
To be sure, a relative can be on the hook for one of the following: co-signing a loan with the decedent if they were a joint account holder; a resident of a community property state where a surviving spouse can be held liable for debts if the state requires the surviving spouse to pay off debts; or if they share in the debt, according to Pierre.
“If you’re alive and well, get a life insurance policy and at least have a simple will,” says Pierre. “Depending on your wealth, look at getting an estate. If you don’t and something unexpected happens, it could take years to figure out how assets should be settled.”
“If you don’t prepare,” Pierre adds, “you’ll be preparing to fail.”