By Brian Figeroux, Esq.

When an individual passes away, their financial and tax obligations do not automatically disappear. Instead, various tax returns must be filed to ensure compliance with federal tax laws. The process involves handling the decedent’s final federal income tax return, the estate’s income tax returns, and evaluating postmortem tax elections that can optimize tax liability for beneficiaries. Understanding these obligations is crucial for executors, personal representatives, and tax professionals handling a decedent’s affairs.

1. Filing the Decedent’s Final Federal Income Tax Return (Form 1040)

Who Must File the Final Return?

The responsibility for filing the decedent’s final Form 1040 falls to the executor, personal representative, or administrator of the estate. If no executor has been appointed, a surviving spouse or any person in possession of the decedent’s property may file the return.

Deadline and Filing Status

The final federal income tax return is due on April 15 of the year following the decedent’s death. If the decedent passed away in 2024, the final return is due on April 15, 2025. The filing status depends on the decedent’s marital situation at the time of death:

• If married, the surviving spouse may file as married filing jointly for the final tax year.
• If single, the return should be filed as single or head of household, depending on qualifications.

Income and Deductions

The final Form 1040 reports income earned from January 1 until the date of death. Income received after the date of death is reported on the estate’s income tax return.

• Income to report: Wages, Social Security benefits, retirement distributions, interest, dividends, and capital gains received before death.
• Deductions allowed: The decedent may claim standard deductions or itemized deductions, including medical expenses and charitable contributions.
• Medical expenses election: Medical expenses paid within one year of death can be deducted on the final 1040 or used as a deduction on the estate’s income tax return.

Tax Refunds and Payment of Liabilities

• If a refund is due, Form 1310 (Statement of Person Claiming Refund Due a Deceased Taxpayer) may be required.
• If taxes are owed, the executor or personal representative must ensure payment using available estate assets.

2. Filing the Estate’s Federal Income Tax Returns (Form 1041)

What is Form 1041?

Upon death, a decedent’s assets become part of their estate, which is considered a separate taxable entity. The estate earns income through interest, dividends, rental income, or capital gains from the decedent’s property. Form 1041, U.S. Income Tax Return for Estates and Trusts must be filed if the estate earns more than $600 in gross income in a tax year.

Filing Requirements

• The estate’s tax year begins on the date of death and can either follow a calendar year (ending December 31) or a fiscal year (up to 12 months after death).
• The executor chooses the estate’s tax year, which can impact tax planning.

Taxable Income and Deductions

• Income sources: Interest, dividends, rental income, royalties, and gains from asset sales.
• Deductions: Funeral expenses, estate administration costs, investment fees, and charitable contributions.
• Exemptions: The estate receives a $600 personal exemption, but there is no standard deduction.

Distributions to Beneficiaries

The estate can pass taxable income to beneficiaries, who must report it on their individual returns. Schedule K-1 is issued to each beneficiary reflecting their share of the estate’s taxable income.

3. Key Postmortem Tax Elections

Postmortem tax elections help minimize estate tax burdens and optimize tax efficiency for beneficiaries. Executors should evaluate these options carefully.

1. a) Section 645 Election (Treating a Revocable Trust as Part of the Estate)

If the decedent had a revocable living trust, an election under Section 645 allows the trust to be taxed as part of the estate, simplifying tax filings. This election is advantageous because:

• It extends the deadline for trust tax filings.
• It allows the estate to choose a fiscal year, potentially deferring tax payments.

1. b) Section 303 Election (Stock Redemption for Estate Taxes)

If the estate holds closely held business stock, a Section 303 election permits a stock redemption (buy-back) without it being taxed as a dividend. This strategy provides liquidity to pay estate taxes without a significant tax burden on beneficiaries.

1. c) Section 6166 Election (Deferring Estate Tax on Business Interests)

For estates heavily invested in a family business, Section 6166 allows the executor to defer estate tax payments for up to 14 years. This prevents the need for an immediate business sale to cover tax liabilities.

1. d) Alternate Valuation Date Election

Instead of valuing assets on the date of death, the executor can elect an alternate valuation date (six months after death) if it results in a lower estate tax liability. This election benefits estates where asset values have declined postmortem.

1. e) Special Use Valuation (Section 2032A)

For estates that include farmland or closely held business real estate, Section 2032A permits valuation based on the property’s current use rather than its fair market value. This election significantly reduces estate tax liability for agricultural families.

1. f) Marital Deduction and Portability Election

• Unlimited Marital Deduction: If the decedent leaves assets to a U.S. citizen spouse, the estate pays no federal estate tax on those transfers.
• Portability Election: If the deceased spouse’s estate is below the federal estate tax exemption ($13.61 million in 2024), the executor can file Form 706 to transfer unused exemption to the surviving spouse.

1. g) Deducting Administrative Expenses on Form 1041 or Form 706

Certain estate administration expenses, such as legal and accounting fees, can be deducted on either the estate’s income tax return (Form 1041) or the estate tax return (Form 706). Choosing the most beneficial option can reduce overall tax liability.

4. Practical Steps for Executors and Personal Representatives

Handling tax filings for a decedent and their estate requires a methodical approach:

1. Obtain IRS Employer Identification Number (EIN) for the estate using Form SS-4.
2. Gather tax documents (W-2s, 1099s, bank statements, brokerage records, real estate valuations).
3. Consult with a tax professional to evaluate postmortem elections and tax planning strategies.
4. File the final Form 1040 and determine if an estate tax return (Form 706) is needed.
5. Monitor tax obligations for the estate, filing Form 1041 as required.
6. Ensure beneficiaries receive tax documents (Schedule K-1) if estate income is distributed.

Conclusion

Handling a decedent’s tax affairs involves multiple filings and important elections that can significantly impact the estate and its beneficiaries. Executors must file the final 1040, determine if an estate tax return (Form 706) is required, and manage estate income tax returns (Form 1041). Additionally, strategic postmortem tax elections can minimize estate tax burdens and maximize financial benefits for heirs. Executors should work with legal and tax professionals to navigate these complexities efficiently while ensuring compliance with federal tax laws.