Trust and Estate Tax Returns

  • Tax Returns Even When You Die? 

    As Executor or Successor Trustee you may be responsible for filing tax returns for the decedent and the estate or trust.

    Income Tax Returns

    • Often a final 1040 personal income tax return, and a State version, is required to report income and expenses up to the date of death.
    • A 1041 Fiduciary Income Tax Return, along with the State version, is filed to report income and expenses from after the date of death until the final distribution to the beneficiaries.  The income and expenses are produced or incurred by the assets of the estate or trust, in which you are administering, such as interest and dividends, and sales of assets.
    • Estate and Gift Tax Returns (Form 706 or 709)   These are asset tax returns, sometimes called “transfer tax returns” and are very different than Income Tax Returns.  On these, taxes are calculated based on the value of assets, not income earned by those assets.

    Estate and Gift Tax Return Summary

    Estate and Gift Taxes are based not on income, but on the net value of assets “transferred” between one person and another.  This can happen either by a gift during a person’s lifetime or at death.  Estate and Gift Tax is cumulative tax, based on the total net value of assets transferred during a person’s lifetime and at death. Each person also has a lifetime credit against the combined Estate and Gift Tax. See chart below for the current amounts.    

    Federal estate taxes (which currently mirror gift taxes) have a current rate of 35%. When combined with inheritance taxes imposed by many states, the combined estate taxes could climb to 46% or higher. Estate taxes are due to the IRS nine months from date of death. Often the estate is forced to sell assets at below market value in order to pay for this tax bill.

    Gift and Estate Tax is a cumulative tax computed on all taxable transfers made over a person’s lifetime (gifts), and at death (estate).  In computing the tax any prior gifts need to be considered in computing the tax rate, and credit for the current return.

    Congress has created uniform tax rates for gifts and estate transfers of wealth.

    The Estate Tax Credit allows every American citizen to pass, after death, a certain amount of their estate to heirs tax-free.  If the total amount of taxable “transfers” that a person makes during their lifetime and at death, is less than the current exemption amount, then no tax is owed.  The Estate Tax Credit has gradually been increasing.

    For 2010 there was a full repeal of both estate taxes and gift taxes (for 2010 only).  For tax years 2011, a special $5 million estate tax exemption was created. And for 2012, the $5 million estate tax exemption was adjusted for inflation, resulting in a total exemption of $5,120,000.

    Here’s a breakdown of the Estate and Gift Tax Credits and top Unified Tax Rates:


    Max. Estate Tax Credit

    Max. Gift Tax Credit

    Max. Unified Rate


    $1 million

    $1 million



    $1 million

    $1 million



    $1.5 million

    $1 million



    $1.5 million

    $1 million



    $2 million

    $1 million



    $2 million

    $1 million



    $2 million

    $1 million



    $3.5 million

    $1 million




    $1 million



    $5 million

    $1 million



    $5.12 million

    $5 million



    $1 million

    $5 million


    Thanks to the new legislation, estates will be taxed at 35% on all amounts over $5.12 million.

    The Gift Tax Credit for 2012 and 2013 allows a $5 million exclusion and is higher than the 2013 Estate Tax Credit for the first time.  As the table demonstrates, the Gift Tax Credit historically has not been as large as the Estate Tax Credit. For gifts made in 2002 or later, the gift tax maximum exclusion was locked at $1 million. This gift tax exclusion remained in effect for subsequent years.  However, the new Tax Relief Act of 2010 provides for estate and gift tax rates to be unified once again.

    For more information on Gift Taxes and gifting during lifetime, see our article: Gift Taxes


    Married Couples and Estate and Gift Taxes

    Gift and Estate tax is imposed on each individual, there is no joint Estate and Gift Tax for married couples. Each spouse has their own amount that they can exclude from Estate and Gift Tax.  If planned properly, a married couple can exclude double the amount of a single person, but it requires proper planning.

    Unlimited Marital Deduction

    An unlimited amount of assets may pass from one spouse to another without any tax.  Without planning, if a spouse receives the entire amount of an estate there will be no tax on a first death.  Having all assets pass directly to a spouse however is often not the best outcome.  If not planned properly the first exemption may be lost.  It is critical in moderate to large estates that tax planning be done to avoid this extra tax.  Understanding the opportunities and tax traps for married couples is very important and can be costly, if not planned for.

    Estate Tax Returns

    An Estate Tax Return is required when the net value of an Estate (after all allowable deductions, and adding back all prior gifts) is over the exemption amount, currently $ 5,000,000 for 2012).

    An Estate Tax Return is a report of the value of all assets in an individual’s estate as of the date of their death.  This may be very different from what is included in a Probate Estate, which you may also be responsible for.  Many items may pass directly to beneficiaries without going through the probate process.  Examples are jointly held real estate, life insurance or pension accounts with designated beneficiaries, joint bank accounts, and transfer on death brokerage accounts.  As trustee or executor of the estate you may have little or no control over these accounts.  You still need to report all of these items for tax purposes.

    Some assets, such as real estate, works of art, or interests in a privately held business, can be very difficult to value.  Professional appraisals may be required.  Sometimes the IRS or a beneficiary will challenge the estate over the taxable value of a gift or asset.

    Estate Expenses

    Estates are also allowed to deduct certain expenses from the total value of assets.  Expense deductions of an estate fall into three categories.

    • Debts of the decedent—including mortgages, auto loans, credit cards balances, and all debts and bills due at the time of death, such as utility bills, property or income tax, or final medical expenses.
    • Expenses in administering the estate—including professional fees, such as legal or accounting, and trustee or executor fees.  Funeral expenses, and administration expenses, such as copies of death certificates or other documents, postage, office supplies, and reimbursement for telephone or travel expenses.
    • Charitable Contributions—paid from the estate.   Any donations to qualified charitable organizations made from estate assets will reduce to net value of an estate.


    Payment of Estate and Gift Taxes

    The due date for the Estate Tax Return is the end of the ninth full month after date of death, and any tax is due at that time.

    Gift Tax Returns are filed on an annual basis for the prior year, and have the same due date as regular Income Tax Returns, April 15th.

    There is no tax due on the filing of a Gift Tax Return until the cumulative total of all taxable gifts exceeds the exemption amount ($5,000,000 currently).

    Returns are required each year in which a taxable gift is made so the IRS can keep track of the total amount of gifts made.  If total gifts are less than $ 5,000,000 then most likely, no tax will be due.  However the total of all gifts reduce the exclusion available on the final Estate Tax Return.

    When filing the Estate Tax Return, the trustee or executor of larger estates must check and take into consideration whether any taxable lifetime gifts where made prior to death and reduce the exclusion amount appropriately.

    See our article: Gift Taxes for more information.


    Final Income Tax Returns

    A regular income tax return, Form 1040, is usually required for an individual for the year of their death.  Any income or expenses up to the date of a person’s death are reported on their final 1040.

    Income or expenses from a person’s assets after death are reported on the Fiduciary Income Tax Return discussed in the next section.  The final income tax return is due on the regular tax return due date, April 15th of the year after death.  All regular income tax rules apply to the final tax return for what is reportable income, allowable expenses or credits, and computation of any tax on the taxable income.

    Allocating Income and Expenses in the year of death between amounts to be reported on the final Income Tax Return, and what will be reported for the last part of the year on the Fiduciary Income Tax Return.

    Single decedents

    Any tax which may be owed is the responsibility of the estate to pay.  Any refund to be received is an asset of the estate.  The administrator of the estate is responsible for filing, and signing, any final tax return for that person.

    Married decedents

    Requirements for a final tax return for someone who is married at the time of their death may be more complicated.  Generally, the death of a spouse does not terminate the tax year on a joint tax return.

    However, under terms of some wills or trusts, assets of the spouse who dies may be immediately transferred to a trust or estate.  The income from those assets from the date of death forward would be reported on the Fiduciary Tax Return.  In the year of death income would be allocated between the joint Income Tax Return and the Fiduciary Tax return, in the case of one of these trusts.

    Fiduciary Income Tax Returns

    A fiduciary income tax return is a report of income and expenses for a taxable estate when gross income is received during a year of more that $100 for a trust, or $600 for an estate.  A taxable estate is generally created when someone other than the creator or donor of assets becomes responsible for administering those assets as the Fiduciary.  The estate or trust becomes the actual legal owner of the assets.

    Step-up in Basis at Death

    When property is inherited, generally, the basis is “stepped-up” to an amount equal to the value at the date of death.  This is also the value that is included on the Estate Tax Return, and subject to estate tax.

    The “step-up” in basis attaches to the property and carries to a trust or estate or to an individual who later received that asset directly.  When that asset is later sold by the trust or estate, and the proceeds distributed to beneficiaries that sale is reported on the Fiduciary Income Tax Return.  The tax consequences are usually minimal because of the new basis based on the valuation as of date of death.

    Tax paid on Income Earned by a Trust or Estate

    If income is retained in the trust or estate, then the trust or estate must pay the tax on that income.  If the income is instead distributed to the beneficiaries, then the beneficiaries will pay the tax on the income they receive.

    When the Fiduciary Income Tax Return is prepared a K1 statement is prepared for each beneficiary who received income from the trust or estate.  Beneficiaries must include this income on their personal tax returns.

    Tax Consequences to Beneficiaries

    The general rule is that any asset or cash received by a beneficiary as either a gift, or inheritance, is not taxed to the beneficiary.  The two exceptions are if the distribution includes income earned by an estate or trust, see the proceeding section, or if a beneficiary receives deferred income, either from a retirement account or insurance annuity.  This is money that has never been taxed, or only partly taxed.

    The good news is these taxable distributions are not subject to early distribution penalty, even when paid to someone not yet at retirement age.  Distributions from these accounts can be timed, and possible extended out over a number of years in a way to reduce the tax impact of the distribution.

    As discussed before, inherited property gets a “step-up” in basis.  Unfortunately, property received as a gift does not get a step-up in basis.  The basis to the recipient is the same as the basis to the person giving the gift.  Even though for estate and gift tax purposes it is taxed at its current value.

    Generation Skipping Tax

    When you gift over $5 million to grandchildren (effectively “skipping” a generation), the IRS slaps a double tax on you. In fact, the IRS treats such a gift as “two gifts in one” and slaps a 35% tax on the gift twice.

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