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Tax Considerations

The personal representative of a decedent’s estate is responsible for filing various tax returns. This may include the filing of final tax returns for the decedent as well as tax returns for the estate which is a separate taxpayer.

Decedent’s Tax Returns

When a person dies, that person ceases to be a taxpayer. However, there may be final tax returns that need to be filed for that decedent. The personal representative is responsible for filing the decedent’s tax returns such as federal, state and local income tax returns and federal gift tax returns. Those tax returns are due on the normal filing date, for example, April 15 of the year following the tax year. For the year of death, the tax return covers the period from January 1 to the date of death (assuming that the decedent filed his or her tax returns on a calendar year basis).

There may be more than one set of tax returns that need to be filed. If the decedent died on March 15, 2006, there may be tax returns due for 2005 and tax returns due for the short year from January 1, 2006 to March 15, 2006.

The tax forms to use for income tax purposes for the decedent are those in the form 1040 series. The tax forms to use for income tax purposes for the estate are those in form 1041 series. Federal gift tax returns cover the calendar year and are due on April 15 of the following year, the same as federal and state income tax returns.

The federal gift tax return is form 709. Michigan does not have any gift tax.

In order to be aware of any correspondence from the Internal Revenue Service to the decedent, the personal representative may file a form 56 with the Internal Revenue Service advising the Service of the decedent’s death and the name and address of the personal representative.

Tax Returns for the Estate

When a person dies, his or her estate becomes a new taxpayer for income tax purposes. The personal representative applies for a new taxpayer identification number on a form SS-4. The number that is assigned is used on any accounts in the name of the estate such as bank, credit union and brokerage accounts.

The personal representative is also responsible for filing tax returns for the estate. These may include a federal estate tax return and federal and state income tax returns. Michigan no longer has an inheritance tax or an estate tax.

If a person dies during 2006, 2007 or 2008 and his or her gross estate is valued at more than $2,000,000, the personal representative is required to file a federal estate tax return, form 706. The dollar amount for filing a return will be increasing over the next several years as follows:

YEAR OF DEATH DOLLAR AMOUNT

2006 - 2008 $2,000,000 2009 $3,500,000

In 2010, the federal estate tax is scheduled to be repealed. However, it is repealed only for 2010 and comes back in 2011.

The “gross estate” for federal estate tax purposes consists of everything that the decedent owned at the time of his or her death including property that is not part of the probate estate such as jointly owned property and property that passes by beneficiary designation such as life insurance and retirement benefits.

The federal estate tax rate is 46% for 2006 and 45% for 2007, 2008 and 2009.

As mentioned above, the estate is a new income taxpayer and it must file income tax returns and pay tax if any is due. For federal income tax purposes, an estate must file an income tax return if the estate has gross income of $600 or more for the tax year. The estate income tax return is form 1041.

Unlike most individuals, an estate may select a fiscal year that ends at the end of any month so long as the first year does not exceed 12 months. For example, the personal representative of the estate of a person who died on November 15, 2005 can select as the first tax year the period from November 15 to the end of any month during the period ending October 31, 2006. Thereafter the estate must file its tax returns for the year ending on the month selected. If the personal representative in the above example selected March 31, 2006 as the end of the first fiscal year of the estate, then the estate would continue to file tax returns for the year ending March 31. The estate income tax returns are due by the 15th day of 4th month after the end of the estate’s fiscal year. If the estate’s fiscal year ended on March 31, the tax returns would be due by July 15 of the same year.

Estates do not have favorable income tax rates. For an estate with a tax year starting in 2005, the estate is at the highest income tax bracket, 35%, when it has taxable income of $9,750. For an estate with a tax year starting in 2006, the estate is at the highest income tax rate when it has taxable income of $10,050.

A personal representative also has many tax elections to consider and exercise or not exercise. Many of these may be beneficial to the estate or to the beneficiaries of the estate. These include such things as electing a fiscal year (discussed above), determining whether to file a joint return with the surviving spouse for the decedent’s final income tax returns, and determining whether to take medical expenses as an income tax deduction on the decedent’s final tax returns or claiming those deductions as estate tax deductions.

An estate must report its income on its income tax returns. If the income is accumulated during the estate’s tax year and is not distributed to the beneficiaries, the estate pays the income tax. On the other hand, if the personal representative makes a distribution of property to the beneficiaries during the tax year, the income may be carried out to the beneficiaries who receive the distribution. In that case, the estate gets a deduction and the income is attributed to the beneficiaries. They report it on their personal income tax returns. Each beneficiary will receive a form K-1 informing the beneficiary of the amount and character of the income.

The rules relating to death taxes and income taxes for estates are complicated. A personal representative would be well served by hiring the services of someone who is experienced in preparing tax returns of the type discussed above. [go to top]

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