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Handling tax obligations during probate can feel overwhelming, but understanding what’s required helps you navigate the process with confidence. When someone passes away, their estate may face various tax filing requirements at both federal and state levels. Let’s walk through each type of tax obligation you might encounter.
You might discover that your loved one didn’t file tax returns for some years before their death. Don’t panic – this happens more often than you’d think. While late returns do trigger penalties, these can often be reduced or eliminated entirely through proper procedures. The key is addressing them systematically rather than ignoring the problem.
The decedent’s final tax return covers only the income they received and expenses they incurred up to their date of death. Think of it as their tax year ending on that date rather than December 31st.
Important deadlines and options:
Special considerations for surviving spouses: If your spouse passed away and no estate administrator has been formally appointed by the end of the year, you have an interesting option called the Section 6013(a)(3) election. This allows you to treat your deceased spouse as if they lived the entire year and file one joint return combining both of your income and expenses.
For the next two years after your spouse’s death, if you have a dependent child, you can use the beneficial “Qualifying Widow(er)” filing status. This provides the same tax advantages as married filing jointly, including potentially lower capital gains rates if you need to sell inherited assets.
Medical expense deduction opportunity: Under Section 213(d), medical expenses paid within one year of death can be deducted on the final income tax return instead of the estate return. This often provides better tax savings since individual returns have more favorable tax brackets.
Once someone dies, their estate becomes a separate taxpaying entity that may need to file its own annual tax returns.
You must file an estate income tax return if:
The estate’s first tax year starts on the date of death and initially runs through December 31st. After that, you’ll file annual returns until you make final distributions and close the estate.
Here’s something many people don’t realize: estates can choose either a calendar year or a fiscal year for tax purposes. While calendar year is the default when you get your Employer Identification Number (EIN), choosing a fiscal year often provides significant advantages:
Estates enjoy much more favorable tax brackets than trusts. While trusts hit the highest federal tax rate (37%) once they have just $15,200 of income, estates can use the same graduated tax brackets as individuals. This means an estate with $50,000 of income might pay tax at 22%, while a trust would pay 37% on most of that income.
If the decedent had a revocable trust, you can make a Section 645 election (filed on Form 8855) to treat the trust as part of the estate for income tax purposes. This election is available for the first two years after death and can result in substantial tax savings.
The estate can deduct various administration expenses, and you have strategic choices about where to claim them. Under Section 642(g), you can elect to deduct estate administration expenses either:
Deductible expenses include funeral costs, executor commissions, attorney fees, accountant fees, court costs, and certain taxes owed at death.
Just like individuals, estates must make quarterly estimated tax payments if they expect to owe more than $1,000 in tax. This requires you to project the estate’s income throughout the year and make timely payments.
Net operating losses and capital loss carryforwards belong to the estate and can be lost if there’s no income to offset them in future years. Smart timing can preserve these benefits:
With the federal estate tax exemption at $15 million per person in 2025, most estates won’t owe any estate tax. However, you might still need to file Form 706 in two situations:
Portability Election: If you’re a surviving spouse, filing Form 706 allows you to claim any unused portion of your deceased spouse’s exemption. Without making this “portability” election, you lose that benefit forever. This becomes valuable if your own estate might exceed the exemption limit when you pass away.
QTIP Election: If your spouse left assets in trust for you (common in second marriages), you might need to make a “QTIP election” to qualify those assets for the marital deduction. This allows the first spouse to avoid estate tax while ensuring the trust assets will be taxed when you pass away.
Form 706 is due nine months after death, though you can request a six-month extension.
You might need to file gift tax returns for large gifts the decedent made during their lifetime but never reported. While there’s usually no tax due (thanks to the lifetime exemption), filing these returns serves two important purposes:
When you inherit assets, you generally receive them with a “stepped-up basis” equal to their fair market value on the date of death. This eliminates capital gains tax on any appreciation that occurred during the decedent’s lifetime.
If you inherit real estate or business assets, you might qualify for bonus depreciation, which can provide substantial tax benefits in the first year you own the assets.
S Corporation stock requires immediate attention because:
Be aware that family settlement agreements can create unexpected tax consequences. If the agreement gives someone more than they were entitled to under the will or state law, the “excess” might be treated as a taxable sale between family members.
Inherited retirement accounts don’t go through probate but create their own tax planning opportunities and traps:
If the decedent or estate had foreign bank accounts or assets, additional reporting may be required:
Form 114 (FBAR): Required when foreign bank or financial accounts exceed $10,000 Form 8938: May be required when making distributions to foreign beneficiaries
These forms have significant penalties for non-compliance, so don’t overlook them if there are any international connections.
State tax obligations become complex when:
Here’s something that’s frequently overlooked: some assets, particularly financial accounts, may be considered to “transfer” to Texas when you open an estate here. This can eliminate tax filing requirements and tax liability in other states where the decedent previously lived or owned assets.
In Texas, you must file annual renditions for:
Don’t be surprised if you need to protest the appraised values – this is common and often necessary to ensure fair taxation.
If the decedent had a homestead exemption on their primary residence:
The key to managing estate taxes successfully is understanding your obligations early and planning accordingly. Each estate is unique, and the interplay between different types of taxes can create both opportunities and traps.
Consider consulting with tax professionals who specialize in estate matters, particularly for:
Remember, proper tax planning during estate administration can save thousands of dollars and prevent problems down the road. Take time to understand your obligations and explore available opportunities – your beneficiaries will thank you for it.
With that said, we can continue on to a related topic, namely, accountings. There are various rules for accountings that have to be considered. Click here to continue reading >>>>
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