Learn About the Taxes Due After Someone's Death
When someone dies, taxes are not going to be the first thing on the minds of the loved ones left behind. But, unfortunately, at some point, the heirs of the deceased person's estate or the beneficiaries of the deceased person's trust need to address taxes that will be due as the result of their loved one's death. Below you will find a list of taxes that the estate or trust of a deceased person may owe and the types of tax returns that will need to be filed.
NOTE: Tax laws change and the following information may not reflect recent changes in these laws. For current tax or legal advice, please consult with an accountant or an attorney since the information contained in this article is not tax or legal advice and is not a substitute for tax or legal advice.
While estate taxes seem to get all of the publicity when it comes to taxes owed after someone dies, the reality is that the majority of estates will not owe any federal estate taxes.
Why not? Because in 2019 the federal estate tax exemption is $11.4 million, and the exemption will only continue to be adjusted upwards on January 1 of each year in the future based on inflation.
Nonetheless, estates valued at $11.4 million or more must file a federal estate tax return using IRS Form 706, which is officially called the United States Estate (and Generation-Skipping Transfer) Tax Return.
Estates of nonresident, alien decedents that owe U.S. federal estate taxes must file IRS Form 706-NA, which is officially called the United States Estate (and Generation-Skipping Transfer) Tax Return Tax Return of nonresident not a citizen of the United States.
While most estates will not have to file a federal estate tax return or pay any federal estate taxes, the residents of the following states, or a deceased person who owns real estate in one of these states, may owe state estate taxes: Connecticut, Delaware, District of Columbia, Hawaii, Illinois, Maine, Maryland, Massachusetts, Minnesota, New Jersey, New York, Oregon, Rhode Island, Tennessee, Vermont and Washington. Click on the link for each state to learn more about each state's estate tax exemption and state estate tax return filing requirements.
While an estate tax is a tax that is based on the overall value of the deceased person's estate, an inheritance tax is based on who receives the deceased person's property. Currently, only six states collect a state inheritance tax: Iowa, Kentucky, Maryland, Nebraska, New Jersey and Pennsylvania - that's right, Maryland and New Jersey collect both state estate taxes and inheritance taxes.
So which beneficiaries of an estate may have to pay state inheritance taxes? The good news is that in all six states assets passing to the deceased person's surviving spouse and charity are exempt from the state inheritance tax, while in several - Iowa, Kentucky, Maryland and New Jersey - assets passing to the deceased person's descendants are also exempt.
Thus, the likelihood of an inheritance being subject to a state inheritance tax is minimal at best. For more information about state inheritance taxes, refer to the State Inheritance Tax Chart.
A type of tax that is often overlooked is the federal gift tax. Two states also collect a gift tax at the state level: Connecticut and Minnesota.
In general, if an estate is subject to federal estate taxes or state estates in Connecticut or Minnesota, then the estate may have to file a gift tax return in order to report any gifts that were made during the deceased person's lifetime that were not reported while the person was still alive.
The federal gift tax return is filed using IRS Form 709, officially known as the United States Gift (and Generation-Skipping Transfer) Tax Return.
At the federal level, generation-skipping transfer taxes, known as GST taxes for short, only apply to estates that owe federal estate taxes where some of the estate is passing to someone who is a "skip person" or some of the estate is passing into a trust that is a generation-skipping trust.
A "skip person" is a relative who is two or more generations below the deceased person, or an unrelated person who is 37 1/2 years or younger than the deceased person.
At the federal level, the generation-skipping transfer tax exemption is the same as the estate tax exemption, which means the exemption is $11.4 million in 2019 and will continue to be adjusted upwards on January 1 of each year in the future based on inflation.
Thus, the majority of estates will not be subject to federal generation-skipping transfer taxes. The generation-skipping transfer tax exemption can be allocated to lifetime transfers using IRS Form 709, or after death using IRS Form 706.
Note: The majority of the states that still collect their own separate state estate tax also assess a separate generation-skipping transfer tax.
Aside from filing a deceased person's final income tax return at the federal level (and state level if applicable), there will be a period of time while an estate or trust is being settled after someone dies that the estate or trust assets will earn interest prior to the time the assets can be distributed out of the estate or trust to the ultimate beneficiaries.
In addition, while certain types of assets owned by a deceased person will receive a step up in basis, if these assets (such as stocks and bonds) are sold after death, then the sale may result in a capital gain even after taking into consideration the step up in basis.
Aside from this, certain types of accounts have built-in income tax consequences referred to as "income in respect of a decedent" (or IRD) when the owner dies, such as non-Roth IRAs, 401(k)s, and annuities.
Thus, while many estates and trusts may not be affected at all by estate taxes, inheritance taxes, gift taxes, or generation-skipping transfer taxes, the majority will be affected in some way or another by income taxes.
Income earned by an estate or a trust is reported on IRS Form 1041, officially known as the U.S. Income Tax Return for Estates and Trusts, for federal income tax purposes, and the estate or trust may also need to file a state income tax return for estates and trusts.