Federal Income Tax Return for the Estate
Besides the final income tax return of the decedent up to the date of death, the personal representative of the estate may need to file an income tax return for the estate starting the day after the date of death. This is for income generated by assets of the decedent’s estate, or income in respect of a decedent. The decedent and his or her estate are separate taxable entities.
After the decedent dies, his or her assets become property of his or her estate. Any income that is generated by those assets is also part of the estate and may trigger the requirement to file an estate income tax return. Examples of assets that would generate income to the decedent’s estate include savings accounts, CDs, stocks, bonds, mutual funds and rental property.
A decedent’s estate figures its gross income in much the same manner as an individual. Most deductions and credits allowed to individuals are also allowed to estates and trusts. However, there is one major distinction. A trust or decedent’s estate is allowed an income distribution deduction for distributions to beneficiaries. Income distributions are reported to beneficiaries and the IRS on Schedules K-1 (Form 1041).
Get an EIN for The Estate (IRS Form SS-4)
The estate of the decedent will need its own Employer Identification Number, which is like the social security number of an individual regardless of whether the estate will have any employees.
Normally, fill out a Form SS-4 with the client’s information and designate myself as the Third-Party Designee and have the client sign it so that I can apply online for the EIN on behalf of the client.
Fiduciary Income Tax Returns
Federal Form 1041 is filed by an estate or trust having any taxable income, or gross income of $600 or more, regardless of taxable income, or that has a beneficiary that is a nonresident alien. By contrast, Form 541 California Fiduciary Income Tax Return must be filed by the estate or trust having net income of $100 or more, or gross income of $10,000, regardless of net income, or that has an alternative minimum tax liability.
To the extent that trust income can be shifted to a beneficiary, such income will be taxed at the beneficiary’s individual income tax rates rather than the higher trust tax rates. Distributable net income (DNI) is a calculation used to allocate income between a trust and its beneficiaries. DNI is used to restrict the amount of the deduction allowable to a trust for distributions to a beneficiary. Beneficiaries are taxed only to the extent of DNI. Distributions made in excess of DNI are treated as tax−free distributions of principal.
A “simple trust” is one that (1) is required to distribute all income in the year in which it is earned, (2) does not have a charitable beneficiary, and (3) does not distribute principal. A “complex trust” is one that does not qualify as a simple trust.
The DNI of a simple trust is apportioned and taxed to the income beneficiaries automatically. The trust pays taxes only on capital gains and other income remaining with the principal, unless capital gains are included in the definition of “income” under the trust.
The DNI of a complex trust is first apportioned dollar for dollar to the beneficiaries who receive the income required to be distributed currently. Remaining DNI is divided proportionately among beneficiaries receiving discretionary distributions or other payments. DNI may exceed the income required to be distributed currently if capital gains are included in DNI.
Selection of the Tax Year for an Estate (or an Electing Trust)
An estate is a separate taxpayer from the decedent for federal and state income tax purposes. An estate does not have to use a calendar year as its tax year. An estate may elect a fiscal year, so long as the ending month of the estate’s initial fiscal year must end no later than the last day of the calendar month that is no more than twelve months from the date of the decedent’s death. For example, if the decedent died January 12, 2018, the initial fiscal year can end no later than January 31, 2019.
Likewise, a trust is also a separate taxpayer for federal and state income tax purposes. However, a trust is required to have a calendar year as its fiscal year. In cases in which there is both a probate administration and a trust administration (there are assets that do not pass under the trust and there is no pour-over will), the executor can elect that the estate and the trust be treated as a single taxpayer and may choose a non-calendar year fiscal year. (IRC § 645.)
Income in Respect of a Decedent
Keep in mind that individuals are generally cash basis taxpayers who report income when they receive it. It is common for the decedent to be owed wages or other earnings in the form of a last paycheck or unpaid commissions. Income in respect of a decedent (“IRD”) is income that would have been income to the decedent but was received after the decedent died. (See IRC §691.) This income will be passed through to, and must be reported on a tax return by, the estate or the individual beneficiary that had the right to receive the income.
Estimated Income Tax for Estates and Trusts (IRS Form 1041-ES)
In general, an estate must pay quarterly estimated income tax in the same manner as individuals. For more information on when estimated tax payments are required see the Form 1041 instructions.
Tax Implications for Sales of Real Estate by the Estate
It is common in an estate to sell the home of the decedent through the probate action. The escrow agent will report the sale of the home to the IRS on Form 1099-S. The escrow agent should report the sale under the EIN for the estate, not the social security number of the decedent. When the estate sells property valued at more than $600, it will trigger the requirement to file a Form 1041 income tax return for the estate. The estate will have to determine its gain or loss on the sale of the property under the usual tax code requirements. (IRC § 1001.)
The amount realized is the sales price of the property. The costs of selling the property is deductible from the amount realized. Then you would subtract the basis of the property, which would be a step-up in basis to fair market value as of the date of death. Any gain or loss on the sale would be reportable on the estate’s Form 1041 income tax return.
California Income Tax Return for the Estate
A Franchise Tax Board Form 541 California Fiduciary Income Tax Return must be filed by the estate or trust having net income of $100 or more, or gross income of $10,000, regardless of net income, or that has an alternative minimum tax liability.
It’s due on April 15 of the following year, or on the fifteen day of the fourth month if the estate has a fiscal tax year.