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How to Omit Tax Problems When Settling an Estate

Troy Werner and his family

Written by Troy Werner

Troy Werner has been an indispensable asset to The Werner Law Firm since joining in 2009, providing exceptional legal service to its clients.

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POSTED ON: July 18, 2019

When a person passes away, everything they own is transferred to others. How exactly that occurs, however, depends on different factors. When a person dies, their assets and wealth become their estate, which is appropriately distributed among their next of kin either according to their own wishes – as per proper documentation – or according […]

When a person passes away, everything they own is transferred to others. How exactly that occurs, however, depends on different factors. When a person dies, their assets and wealth become their estate, which is appropriately distributed among their next of kin either according to their own wishes – as per proper documentation – or according to the laws of the state in which they resided, also known as intestate law.

Either way, regardless of whether someone leaves behind a will when they die or leave no indication of what they want done with their belongings, a special probate court must be called to oversee the total valuation of the estate, and its proper distribution, through the hard work of a trusted executor/administrator. In cases where an estate plan is present, the deceased (known as the decedent) will have pointed out whom they would want to take on the role of executor. If no one is mentioned, the courts appoint an executor, usually someone within the family (the spouse, sibling, or someone else).

From there, it’s the executor’s job to succinctly gather the estate, properly estimate its value, take care of any and all outstanding expenses and affairs, and finally, distribute what remains either as per the decedent’s estate plan, or as per the state’s intestate laws. While none of that is particularly easy, one of the harder tasks is determining exactly what the decedent owes the government, and how best to settle those costs. If ill-prepared, an estate can often be taxed for hundreds of thousands of dollars, if not more, depending on the size of the estate. But with the right preparation and some leg work, painful tax issues can be avoided during the process of executing a loved one’s estate.

What’s an Executor to Do?

If you are the executor of your loved one’s estate, then your job begins with kickstarting the probate process. This is mandatory, and essentially involves going to the courts and formally requesting that probate begins. From there, it’s your job to inform the decedent’s creditors that he or she has passed away. This is traditionally done through a newspaper ad. You do not have to contact the creditors personally – and if they fail to file a claim against the estate within a given timeframe, they do not have the right to file a claim at all.

Once the proper parties have been adequately informed, it’s your job to gather all of the assets, properties, and accounts on paper and work out exactly how large the estate is, and what its total value is. This is important, as it’s critical to know how much money lies in an estate when aiming to settle a decedent’s affairs and determine how much tax money they owe the government.

After doing the accounting legwork to determine the estate’s total value – either as per the value of each asset and property on the date of death, or six months after death (known an alternate valuation death) – it’s time to determine how much of the estate will go towards any outstanding financial matters, including tax returns, legal fees, and potentially, the estate tax.

Filing the Final Tax Return for an Unmarried Decedent

An unmarried decedent will require that their executor – you – file a tax return in their name covering the time period from January 1 through to the date of death. Any deaths occurring in 2019 require that the appropriate tax return is filed on National Tax Day 2020 (April 15). A formal request can extend this deadline to October 15, 2020, six months later.

The right form to file here is a Form 1040, known as an individual income tax return form. Take note that Form 1040-A and Form 1040-EZ are obsolete, and all taxpayers are instead to use the improved Form 1040, unless certain complications require the filing of new Form 1040 Schedules. Refer to more information from the IRS to determine that.

Filing the Final Tax Return for a Married Decedent

If the decedent left a surviving spouse, said spouse will typically oversee filing the final tax return. Married couples can file joint tax returns, and a surviving spouse may file their loved one’s final tax return in one last joint tax return, which grants friendlier rates. However, if the surviving spouse remarries within the year of the decedent’s death, they must file a separate tax return for the decedent.

Revocable Living Trusts and Tax Returns

Most Americans die intestate, and some have a last will and testament. But many Americans with larger estates seek to reduce the size of their estate either to avoid the probate process or avoid the federal estate tax, typically making use of a revocable living trust to transfer assets into the trust rather than retain ownership over them at the time of their death.

If you are an executor for a revocable living trust, also known as a grantor trust, the contents of the trust are treated as though they were still in the grantor’s (decedent’s) possession. The main purpose of a revocable living trust is to avoid probate, not taxes. If the decedent was unmarried and leaves no kin, their grantor trust becomes irrevocable and incurs severe taxes. This can be potentially avoided by distributing the trust upon death (to avoid hefty taxes on undistributed trust income) or terminating the trust.

Regarding Estate Taxes

This is where the total gross value of the estate comes into play. Any estates valued at or over $11,400,000 in 2019 (if 2019 was the decedent’s year of death) must pay a hefty federal estate tax. There are no state estate taxes in California. Estates under this total value are exempt from estate taxes. An estate can be drastically reduced prior to being taxed through annual gifts, an irrevocable life insurance trust, charitable donations, and other methods.

Consider Professional Help

At the end of the day, an executor is expected to handle an array of administrative, financial, and legal tasks. This can be very overwhelming and may lead to unfortunate errors that can cost thousands of dollars in taxes or legal fees to properly amend.

Doing it right the first time is key, and an estate planning professional is often vital when settling very large estates. While smaller estates are far more manageable, the larger and more complex an estate becomes, the more it’s worth investing in properly managing and executing a well-constructed estate plan.

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