This is a question that comes up from time to time when I am talking with someone who has had a parent or loved one pass away. While the specifics of this question are better answered by a CPA or tax advisor, I can provide some general direction on this question in this post.
The automatic estate
When a person passes away, a new taxpaying entity – the person’s estate – is automatically created to ensure all taxable income is accounted for. Income is taxed either on the taxpayer’s final return, on the return of the beneficiary who acquires the right to receive the income, or if the estate receives $600 or more of income, on the estate’s income tax return.
The chore of filing the taxpayer’s final return usually falls to the executor or administrator of the estate, but if neither is named, a survivor must do it. The return is filed on the same form that would have been used if the taxpayer were still alive, but “deceased” is written after the taxpayer’s name. The filing deadline is April 15 of the year following the taxpayer’s death.
Death tax vs. Income tax
There are three taxes to consider: Estate (death) taxes and estate income taxes are two different types of tax. It is very important to understand the distinction between the two types of taxes. Often, there may be no estate tax due while there very well could be some income tax due. The third type of tax to be considered is the standard income tax that everyone is subject to.
1. Estate death tax is a tax paid on the transfer of property from the deceased person to the people who receive the deceased person’s property. As the IRS puts it “[t]he Estate Tax is a tax on your right to transfer property at your death. It consists of an accounting of everything you own or have certain interests in at the date of death.” To be liable for the federal estate tax, a person passing away in 2014 must have left an estate valued at 5.3 Million or more (and the person had not used up any of this amount during their lifetime). Oklahoma abolished its estate death tax in 2010. A person passing away in Oklahoma in 2014 would not owe any estate tax under Oklahoma law.
2. Estate income tax is a tax on the income received by the estate after a person has died (the “estate” is what I referred to above as the “automatic estate” that is created when the person passes away.) Note that this is different than the final individual income tax return which is described below. Some examples of estate income would be interest, dividends, gains from sales of stock or real estate. This tax might be paid by the estate or beneficiaries. Most estates have to pay or file an estate income tax return(s) with the federal and state government. For the federal government, the executor of the estate (sometimes also referred to as the “fiduciary”) uses the IRS form 1041 to file what is known as a fiduciary income tax return.
3. Individual Income Tax. The executor of the estate is required to file a final income tax return for the person who is passed away. Income earned or received by the deceased person between January 1 and the date of the person’s death is reportable under the person’s Social Security Number.
Are tax returns required?
1. Final Individual Income Tax Return. The executor of the estate is required to file a final income tax return for the person who is passed away. Income earned or received by the deceased person between January 1 and the date of the person’s death is reportable under the person’s Social Security Number. If that amount is sufficient to meet the minimum filing requirements (which change each year), you will need to file a return for the person. Also, if the person had any taxes withheld (e.g. from a pension, or from estimated payments), you will certainly want to file to claim a refund. However, if the person’s income was low and she had not been filing returns, you won’t have to unless she had some special circumstance such as selling stock or a house, cashing in an IRA, or winning the lottery. This is the same return that the person would’ve filed had they not passed away. The final individual income tax return is due on the same day as if the taxpayer had that died. For example, if someone passes away on January 1, 2015, then the final IRS form 1040 will be due on April 15, 2016.
What to do: You can go this page on the IRS website to determine if the person had enough income to require a tax return.
2. Estate Income Tax. An estate income tax return is typically required to be filed if the decedent had an income of $600.00 a year or more or had a beneficiary who is a nonresident alien. In addition to income received while the decedent was living during the tax year, the estate may end up with income through rents on real property received, interest on bank accounts, unpaid salary or dividends.
However, there are some circumstances where if the property is distributed relatively quickly to the people who are to inherit it the estate may not have income and there may not be a need to file an income tax return for the estate. For example, if the person who passed away owned a house in joint tenancy, had transfer on death designations for bank accounts, those assets pass immediately at the time that the person passed away. With the property no longer being owned by the estate, there is no chance for the estate to end up with and come in the form of things like rent received, interest received and things like that. For that reason, those assets very well may not generate income for the estate.
What to do: Determine if the deceased taxpayer’s estate value exceeds the minimum threshold for filing by the IRS and the state taxing authority.
3. Estate Death Tax. If you live in Oklahoma and the person passed away in 2014 or later then no Oklahoma state tax return is required because the estate tax was abolished. For federal tax purposes, if the person passed away in 2014 and the value of their gross estate was less than $5.3 million, no federal estate tax return is required. However, you will want to consult your CPA or tax advisor about this type of issue because there are circumstances where a federal estate and the gift tax return is filed even when no taxes due following a person’s death. Those circumstances are typically when a person is close to the federal exemption number of 5.3 million.
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