Like death, taxes aren’t going away anytime soon, but unlike debt, your taxes don’t go to the grave with you.
In the event of someone’s untimely passing, they’ll still owe the IRS income taxes if they earned any reportable income in the last year of their life. And if you’re a survivor of someone who sadly died in 2016, someone -- maybe you -- needs to be responsible for filing their final tax return.
It’s not an easy place to be in, grieving a death in the family and sorting out their taxes as well as your own. The tax deadline of April 18 is fast approaching and it’s not just income taxes that come into play. Estate matters and other factors can further complicate the process.
Determining who actually handles the taxes
Say you’d like to volunteer yourself to the task of filing a relative’s taxes. You may have no legal authority until a judge appoints someone -- in many cases, it’ll be a decedent’s spouse or next of kin.
If the person has left a will, whomever they’ve named as the executor in charge of their estate and handling of existing financial and probate matters will also manage the filing of their income taxes. With no will or no executor named, it’ll be up to a court to select one. (They may also be an administrator or someone in charge of the deceased’s assets and property.)
For the purposes of this article, we’ll assume that you are the primary executor and you’ll be handling your loved one’s taxes. At this point, consider hiring the services of a tax professional. They may be able to offer guidance on certain issues, like figuring out if certain investments or earnings from the year prior are tax advantaged.
Collect your standard documentation
Once you start the process, it’s not all that different from doing your own taxes or those of another family member.
With your own taxes, you’ll have a general idea of how much you’ve earned throughout the year, what some of your deductions might be, or if you’re an independent contractor, how many clients you have -- and thus, how many different 1099s you’ll be getting. You know your own tax situation best.
But with someone else, you’re embarking an unfamiliar discovery process, so it’s important to make sure you gather all the information you need to file. It’s even recommended that you gather up the last three to five years of the deceased’s tax returns, just to make sure you haven’t overlooked any uncollected taxes or unreported income.
Despite the fact that they’ve passed away, they were a taxpayer like anyone else, so the primary tax documents you’ll need will be the same as yours, like:
A final 1040 form to file (or 1040A or 1040EZ, depending on one’s filing status)
W-2s for tax-withheld income
1099s for untaxed income
For determining the deceased’s income, you’ll count it from January 1 of the previous tax year until the day before they died. If they passed away on July 27, their finalized 1040 form will reflect the first day of the year until July 26. If the deceased person was married, and you’re choosing to file jointly, the tax return will include income and expenses of the deceased spouse until the time they died, plus the surviving spouse’s taxes until the end of the year -- those can be combined.
Take medical expenses into account
Unpaid, uninsured medical expenses from 2016 need special attention when filing the final tax return. IRS rules allow you to deduct these outstanding medical bills -- along with those that were paid -- so long as they’re greater than 7.5 percent of the deceased’s adjusted gross income if they were under age 65, 10 percent over 65. You’ll be able to determine their income through their W-2s or 1099s.
To claim deductions on these medical expenses, they’ll need to be paid off within a year of the deceased’s time of death.
The other thing to keep in mind with medical expenses is that you can deduct them from the estate’s federal estate tax return, which is owed if the estate is worth more than $5.45 million (if the person died in 2016), or $5.49 million for a 2017 death. If the estate is worth less, you don’t need to worry about this step.
How to count investments and inheritances
You’ll file a Form 1040 for the decedent’s final income earned during their lifetime. What about income earned after they’ve passed away? For that, you’ll need to fill out an additional Form 1041 -- a separate tax return listing income earned from investments, retirement accounts, mutual funds, life insurance policies, property, or other assets that may go towards the decedent’s estate.
Like a 1099, a 1041 needs to be filed if the estate earned more than $600 in gross income, or if said assets earned interest before being paid out to beneficiaries. If there was any extra money, like salary earnings that hadn’t yet been paid to the decedent before he or she died, it’ll need to be declared on Form 1041. So, if a family member died and named you as a beneficiary of a 529 college savings fund, a Form 1041 is necessary if the account earned income from in the last calendar year.
It bears repeating that while income tax isn’t debt, it is money owed to the government that comes out of the deceased person’s estate. However, money designated to be paid to beneficiaries isn’t taxable and won’t be touched if the decedent owed taxes for 2016.
Take note that if you’re a beneficiary, money you receive counts as income and must also be reported on your own income tax return.
Additionally, if their estate exceeds the $5.45 million mark, and there’s been a transfer of property or assets to one or more beneficiaries, that property is taxable and needs to be noted on Form 706 -- the estate tax return.
Fill out forms fully and carefully
Treat the final tax return as you would any other, listing the decedent’s income, expenses, deductions and other information. When finished, make sure to write the word "Deceased" at the top of the form, along with the decedent’s name and date of their death. Sign your name at the bottom to signify to the IRS that you’re the executor/representative of the estate.
If a tax refund is due, you can claim it by submitting Form 1310, Statement of a Person Claiming a Refund Due a Deceased Taxpayer.
Surviving spouses should also sign their name with the phrase "filing as surviving spouse" if it’s a joint tax return filing. If someone else is the executor or personal representative, they’ll have to sign their name in addition to the surviving spouse. For joint filings, Form 1310 isn’t necessary.
Exceptions to filing taxes
On a final note, there are examples when taxes don’t need to be filed or paid by the estate of a decedent. If they died while serving on active military duty, or killed in a terrorist attack, the estate is exempt from any tax obligation.
However, you’ll still need to submit the standard tax forms to the IRS, but make sure to include a note detailing the time, nature and location of death, a copy of their death certificate, or any other relevant information, such as a certified letter from the U.S. Department of Defense.