Death of a loved one and taxes

What to do if your spouse or parent dies

Jennifer A. Maas

In the devastating event that you lose your spouse or a parent, the last thing you’ll want to deal with is taking care of final tax arrangements, but it must be done. While there are a few things you can do now to be better prepared down the road, you may deal with the unexpected death of a loved one. So, whether everyone’s affairs are in order – or not – here’s what you need to know about navigating this difficult situation.

Estate planning documents

A good first step is to gather all your loved one’s estate planning documents, so you can get a better sense of their whole financial picture. What are their assets? Do they have any debts? You’ll need a list of all accounts, who’s in charge of those accounts, account numbers and usernames and passwords. It’s important to have all of this because you don’t want to miss valuable assets. (These documents and lists are also something you can have prepared in advance with the help of your attorney and accountant.)

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No idea where to start?

If a loved one passes away suddenly, and you have no clue where their estate documents are, what they have, etc., start with family members. For example, most married couples file their taxes jointly; so, if a parent dies, the surviving spouse will more than likely also be on all accounts and have at least some knowledge of their financial picture. You can also contact their advisors, such as accountants, attorneys and financial planners, for help determining what is in the estate. Let the advisors know your loved one has passed away and they can advise on the next steps or assist with a fact-finding investigation to help you gather the necessary information.

What returns need to be filed?

Depending on the size of your loved one’s estate, there could be a number of returns you’ll need to file. You’ll have to file a final individual income tax return, Form 1040, and report all the deceased’s income for the year from January 1 to their date of death.

Upon death, your loved one’s estate and/or trust becomes its own entity, similar to a corporation, and you will need to file a fiduciary income tax return reporting the income from the date of death through the end of the year. Generally, an estate and/or trust takes some time to settle, so you will need to file a fiduciary tax return each year until it is closed out and the money has been paid to the appropriate beneficiaries.

Finally, you may need to file an estate tax return if your loved one’s estate (plus any past gifts) is worth more than the exemption amount, which is currently $11.4 million in 2019.

Tax penalties

One thing that people often don’t think about is whether their loved one has taken their required minimum distribution (RMD) for the year from any retirement accounts. If your loved one has not done this, you should make sure that the beneficiary of the account takes the RMD from the accounts before December 31 of the year of death. The IRS imposes a penalty of 50% of any shortfall that was not taken out. So, if your parent did not take his or her $20,000 RMD before passing away and the beneficiary did not take it either, the IRS will impose a $10,000 penalty. Sometimes the IRS will waive this penalty due to the death, but it is additional paperwork and headache that will be unpleasant to deal with during an already difficult time.

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What is the family responsible for financially?

If your spouse dies and you file a joint return, the taxing authorities view the surviving spouse as jointly liable on any reported balance due for that year. If your parent dies, his or her estate would be responsible for paying any tax liabilities. If the parent’s estate is insolvent and does not have enough assets to pay all creditors, the children are generally not obligated to pay for their parent’s debts from their own assets. If your loved one’s estate and/or trust is insolvent, it is critical that the person handling the estate seeks legal advice, as there is a very specific order in which creditors must be paid.  If the creditors are not paid in this order, then the person handling the estate could become legally responsible for incorrectly making payment to creditors.

Inheritances

Inheritances are generally not taxable, but any income earned on those inheritances would be. If the estate retains the income in a given year, the estate is responsible for paying the tax. If the estate distributes the income in a given year, the beneficiary receiving the income is responsible for paying the tax. If the estate distributed income, it will provide the beneficiaries with a Form K-1, which will tell the beneficiaries how much income they need to report on their returns.

Start planning now

Estate planning now will ease the burden on your family down the road. Though no one likes to think about or plan for getting their final affairs in order, you never know when something can happen. So, talk to your loved ones and your advisors to be sure everyone is on the same page and all necessary items are addressed. If you have questions about estate planning, be sure to reach out to your Henry+Horne advisor.

 

Jennifer A. Maas, Manager, specializes in estate, gift + trust tax planning and preparation. She can be reached at (480) 483-1170 or JennyM@hhcpa.com.