Tax Issues Related to a Final Estate Tax Return

If you’re dealing with a loved one’s estate, there are a number of tax issues you must consider. While figuring out exactly what is required of you can seem daunting, working with your estate administration attorney and accountant is typically the best way to ensure that all taxes are properly filed and paid.

The most common taxes that are filed on behalf of a deceased individual are those related to income tax and federal estate tax. While most small estates are not subject to the federal estate tax, many larger ones are. For those that are, a special tax return known as Form 706 must be filed. In most cases, this is not a complicated return to file but the executor or personal representative must be very careful about how it is prepared.

When an individual dies, their assets are split into three distinct tax categories: an estate, which is responsible for paying any debts and taxes, and beneficiaries, who are entitled to receive certain property at no charge. Any property not transferred to a beneficiary is subject to income tax, which is typically at the highest rate, 39.6%, plus a 3.8% net investment income tax.

The type of taxes that are required for an estate depend on what kind of property is held by the estate, whether or not it is taxable and how much income is generated. For example, income generated by investments is taxed on Form 1040 while wages are reported on a separate form known as Form W-2. The final tax return for a deceased individual, however, must report both capital gains and losses and must also include any money that was withheld from the deceased’s paychecks.

In most cases, an estate’s first income tax return must be filed using a calendar year although the executor can choose to use what is known as a fiscal tax year. This can allow the estate to extend its filing deadline and allows it to end its tax period on the last day of any month except December.

In addition to reporting income, an estate’s tax return must report various expenses, including administrative costs (e.g., trustee or executor fees), final medical, accounting, legal and appraisals, as well as selling expenses. In addition, the deceased’s unused capital losses and net operating losses pass to the beneficiaries. In some cases, the beneficiaries can use these losses to offset their own income tax liability. However, these carry over to the next tax year. If a beneficiary does not use these losses, they must report them on their own individual income tax returns.

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