When a friend or loved one passes away, dealing with their estate can be an emotional time. However, a methodical approach and guidance from the IRS can help fulfill any tax obligations that may be due. Depending on the size of the estate, it may require filing a final 1040 and one or more Forms 1041. Those who inherit assets that earn income, such as investments in stocks, mutual funds or rented property, must report that on their own individual tax returns (Form 1040). In addition, the executor or trustee of the estate may be responsible for filing a 706 estate tax return, which is required for estates generating more than $5 million.
An estate’s tax year generally starts on the day of death, and ends on December 31 of the same year, but the executor can choose to have a fiscal year accounting period instead. When this occurs, the return is due by April 15 of the following year.
A 1041 is a fiduciary income tax return that’s typically filed when an estate has taxable income. This includes any income that was earned by the deceased person before their death, but also any money they may have received from the estate or trust after their passing. This can include a final paycheck, rent or interest from the deceased’s rental properties, money from their final bank account withdrawal, any investment earnings and more.
Inheritances typically have what’s called a “step up” in basis, which means the value of the asset on the date of death is equal to or higher than its original cost. Gifted assets, however, do not have a step up in basis, which can create some tax issues for beneficiaries who receive those items from the estate or trust.
An estate tax return looks at the total value of the deceased’s assets and adds back in any gifts they made during their lifetime. It’s important to note that very few estates are subject to estate taxes, and most are only due when the total value of an estate is above the threshold for a particular year, which is currently 11.7 million dollars in 2021.
It’s also worth noting that if the estate has unpaid federal income taxes or state income taxes, those must be paid prior to filing the 1041. In many cases, the estate can claim a deduction for those expenses, which would reduce the amount of tax that’s owed. A qualified accountant who serves trusts and estates can assist you with determining what tax forms are required, when they are due and how to properly file them.
