When someone dies, a personal representative or executor is typically responsible for filing the Final Estate Tax Return on behalf of that person. Usually this individual is the deceased person’s spouse or another family member, or an accountant who had the deceased’s account at the time of death.
In the United States, there are two types of tax returns related to a decedent’s death: Form 706 (Estate Tax Return), and Form 1041 (Income Tax Return for Estates and Trusts). The estate tax return is an important part of the overall planning process that should be completed by the estate fiduciary as soon as possible after the death.
This return focuses on the income of an estate or trust from the date of death until distributions to beneficiaries are made. It also enables the estate or trust to claim a deduction for any expenses incurred in managing that income and distributing it to beneficiaries.
A fiduciary generally must file a Form 706 only if the fair market value of the decedent’s gross assets at death exceeds the federal lifetime exemption amount in effect for the year of death, which right now is $11.7 million (2021). Gifts made during life may also trigger an obligation to file a return; if so, the fiduciary must include those gifts on the estate tax return.
If an estate reaches the threshold, the fiduciary can elect to use a “portability” method to reduce or eliminate any tax on the estate’s unused lifetime exemption amount. Alternatively, the fiduciary can document a step-up in basis on the decedent’s assets under IRC section 1014.
It is critical to file a timely Form 706 when a fiduciary decides to use portability. Otherwise, the estate will be subject to additional taxes and penalties for taxable transfers that occurred after the deceased person’s date of death.
The filing deadline for a final estate tax return is nine months after the date of death, unless it is extended. An extension can be filed using Form 7004, Application for Automatic Extension of Time to File Certain Business Income Tax, Information, and Other Returns, or by applying online for a 6-month extension.
Once a final estate tax return is filed, the executor of the estate or surviving spouse may then claim any refunds owed by the IRS to the decedent. This is a simple process that can result in substantial tax savings for the estate and heirs.
In addition to estate tax, an executor can claim a deduction for any fees paid to attorneys, accountants, and other experts on the estate. The executor or surviving spouse must report any fees on their own personal income tax returns, but a reasonable amount of the fee can be deducted from the estate’s income to avoid tax.
The executor or surviving spouse can also choose to report bond interest on the decedent’s final Form 1040 at the low tax rate of 39.6% plus 3.8% net investment income tax, if the estate is in that bracket at the time of death. This can save the estate and heirs significant amounts of tax, particularly for the beneficiary of the bond, who will not have to pay any federal estate tax on the interest.
