Settling Tax Issues on a Loved One’s Estate | Jacobson Lawrence & Company, formerly Rue & Associates

Settling Tax Issues on a Loved One’s Estate

When a love passes away, there needs to be someone that will handle the resulting tax issues and that is the role of the executor. Their job is to identify the estate’s assets, pay off its debts, and distribute the remainder to the rightful heirs and beneficiaries. If the decedent was unmarried, the final Form 1040 covers the period from January 1 through through the date of death.

How to handle final medical expenses for taxes: If large uninsured medical expenses were incurred in the year of death, the executor must make a potentially important choice about how they are treated for federal tax purposes. When federal estate tax is owed, deducting accrued medical expenses on the federal estate tax return is usually the tax-smart option. Because the estate tax rate is 40% while the decedent’s final federal income tax rate could be as low as 10%.

Surviving spouse can usually file joint return for year of death: When there is a surviving spouse who remains unmarried as of the end of the year that includes the decedent’s date of death, the final Form 1040 can be a joint return filed as if the decedent were still alive. This final joint return includes the decedent’s income and deductions up to the time of death plus the surviving spouse’s income and deductions for the entire year. Filing a joint return is usually beneficial, because it allows the surviving spouse to take advantage of the more taxpayer-friendly rates and rules that apply to married joint-filing couples. The tax-rate advantage of joint filer status is extended to a qualified widow or widower for the two tax years following the year that includes the decedent’s date of death.

If decedent had revocable trust: To avoid probate, many individuals and married couples of means set up revocable trusts to hold valuable assets including real property and financial accounts. These revocable trusts are often called living trusts or family trusts. For tax purposes, these trusts are so-called grantor trusts. If the trust remains in revocable status, it is a grantor trust and its existence are disregarded for federal tax purposes.

Unmarried individual’s trust: When an unmarried individual pass, his/ her grantor trust becomes irrevocable. This is an unfavorable development, because the tax rates on undistributed trust income quickly climb to the maximum 37% rate for ordinary income and short-term capital gains and the maximum 20% rate for long-term capital gains and qualified dividends. If the 3.8% net investment income tax also applies, the marginal federal rate on a trust’s undistributed investment income and gains can be as high as 40.8%/23.8%.

Married couple’s trust: For married couples, grantor trusts typically continue to exist as such when the first spouse passes away. In that case, the trust’s existence continues to be disregarded for federal tax purposes, and the surviving spouse’s tax returns are prepared without regard to the trust. However, when the surviving spouse passes away, the trust becomes an irrevocable trust. As such, it is treated as a separate taxpayer with the unfavorable federal income tax consequences.

Tax planning goal with trusts: To avoid the unfavorable federal income tax rates for trusts, it’s generally a good idea to get the income and gains out of the trust by either distributing them to the trust beneficiaries or by winding up the trust.

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