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Federal Tax Matters

What federal tax matters apply when a person dies?

There are several federal tax matters that affect the estate of every person who dies and some that apply only in certain situations. Some of the most common federal tax matters include:

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Do I have to file a federal income tax return for the person who died?

Yes. You will need to file a final Individual Income Tax Return (IRS Form 1040) for the person who died. Usually this return will include income that the person received from January 1 until the date on which he or she died. The due date is April 15 of the year after the year in which the person died. You may also need to file other federal income tax returns for the person who died, including corporate, trust or partnership returns, if the person was involved with a business or a trust.

Preparing income tax returns can be complicated, especially after someone has died. It is a good idea before filing any federal income tax returns to talk to a certified public accountant.

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What if the person died owing overdue federal income taxes?

In some cases, the person who died may owe income taxes for earlier years, may not have filed income tax returns for certain years or may have IRS tax liens on his or her property. Before you transfer property to beneficiaries or heirs, you must make sure that the estate has paid all overdue income taxes and that the IRS has either released all tax liens against the property or agreed to the transfer. The IRS has priority to be paid before most creditors.

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Do I have to pay federal income tax on property I inherit?

For most property, no. Usually you pay federal income tax only on income that the property earns but not on the property itself. For example, if you inherit a checking account, you must pay income tax on the interest earned by the money in the account but not on the total amount of money in the account.

For some property, however, you must pay federal income tax on the entire value of the property. If the property has "built-in" income tax that has not been paid, such as a retirement account to which the person who died contributed tax-free income, that income tax must be paid after the person dies. For certain property, it may be possible to postpone paying the income tax but in other cases, all of the tax will be due right away.

Any federal income tax on inherited property is in addition to any federal estate tax that may be due. Before you accept or use any estate property on which income tax has not been paid by the person who died, it is important to talk to a probate lawyer, a certified public accountant or other financial professional to review your options.

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Do I have to file a federal income tax return for the estate of the person who died?

Yes, if the estate receives a certain level of income. The estate is a separate taxpayer from the person who died and must pay taxes on all income received after a person dies. In some cases, the beneficiary or heir who inherits the property will pay the income tax. You must file an Income Tax Return for Estates and Trusts (IRS Form 1041) to report income earned by the estate.

An estate can pay taxes based on a calendar year, which ends on December 31 of the year in which the person died, or on a fiscal year, which ends on the last day of the month before the person died in the year after the person died. For example, if a person died on August 15, the estate could choose a tax year ending on December 31 of the same year or on July 31 of the next year. If the estate chooses a calendar year, the return will be due April 15 in the year after the person died. If the estate chooses a fiscal year, the return will be due on the 15th day of the fourth month after the fiscal year ends. There may be tax benefits to choosing one type of tax year over another.

Currently, an estate must file an Income Tax Return for Estates and Trusts if it receives more than $600 in income during a tax year. This amount can change each year. Tax returns are due every year until the estate is closed.

Preparing an Income Tax Return for Estates and Trusts can be complicated. It is good idea before filing any federal income tax returns to talk to a certified public accountant.

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Does Alaska have a state individual income tax?

No. However, if the person who died was a resident of another state or earned income in another state, income tax may be due in that state. If you have any questions about state income taxes, you should talk to a probate lawyer, a tax lawyer or a certified public accountant.

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What is the federal estate tax?

The federal estate tax is a tax on all transfers of property at a person's death, including probate property and nonprobate property. It excludes property passing to a surviving spouse or a qualified charity. The taxable amount of the estate includes almost all property owned by the person who died, including life insurance and retirement benefits. Federal estate tax is due if the total amount of the estate, after subtracting debts, liens and other deductions, is higher than a certain value, which is usually at least $1 million. The level at which an estate is taxed can change every year but it is usually at least $1 million. The estate tax rate can be up to 55%.

If the estate is taxable, you must file an Estate Tax Return (IRS Form 706) within nine months of the date that the person died. Although the IRS will give you extra time to file a return, the estate must pay the entire estimated amount of tax due by this date or interest and penalties can be added.

In addition to estate tax, there may be other federal transfer taxes due such as generation skipping tax on property passing to grandchildren or great grandchildren. Preparing a Federal Estate Tax Return and deciding whether other taxes are due can be complicated. If the value of the estate is near $1 million or if you have any questions about estate taxes, you should talk to a probate lawyer, a tax lawyer or a certified public accountant.

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Who is responsible for paying the federal estate tax?

Usually the Personal Representative is responsible for preparing the Estate Tax Return and paying the tax from estate property. Each interested person shares in the tax in a percentage equal to his or her share of the estate, unless the Will says differently. The court can change the percentages in which the interested persons share the tax. The court can also hold the Personal Representative personally responsible for interest or penalties from the Personal Representative's own funds if the interest or penalties are the Personal Representative's fault.

The Personal Representative can deduct the percentage of federal estate tax owed by an interested person before transferring property to that person. If the property is worth less than the tax, the Personal Representative can recover the difference in tax owed from the interested person, even if the person has not received the property. If the Personal Representative has already transferred the property, the Personal Representative can recover the entire tax or remaining amount from the interested person. The Personal Representative can also require that the interested person post a bond to guarantee payment of his or her tax share before transferring the property.

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Does Alaska have a state estate tax?

No. As of 2005, Alaska no longer collects a state estate tax. However, if the person who died was a resident of another state or owned property in another state, estate taxes may be due in that state. If you have any questions about state estate taxes, you should talk to a probate lawyer, a tax lawyer or a certified public accountant.

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What forms should the Personal Representative file with the IRS, other than tax returns?

The Personal Representative should file the following forms with the IRS:

You may need to file other tax forms depending on the circumstances of the person who died. If you have any questions about how to complete these forms or what other forms to file, you should talk to a probate lawyer, a tax lawyer or a certified public accountant.

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What is my federal income "tax basis" if I sell property that I inherited from the person who died?

Special income tax rules apply to inherited property when the property is later sold. Usually when a person sells property, federal income tax is due on the difference between what the person paid and received for the property. The amount on which the difference is based (usually the amount that the person originally paid for the property) is called the tax basis. If the person sells the property for more than what the person paid, the person reports the difference as gain and pays income tax on the gain. If the person sells the property for less than what the person paid, the person reports the difference as a tax loss.

When a person dies and passes property to a beneficiary or heir, the tax basis is adjusted to the value of the property at the date of death. If the beneficiary or heir later sells the property, income tax is due on the difference between the value of the property at the time of the person's death and what the beneficiary or heir received for the property.

For example, if a person pays $10,000 for a parcel of land and sells it for $100,000, the person usually pays tax on the $90,000 difference between the cost basis ($10,000) and the selling price ($100,000). But if the person dies when the property is worth $60,000 and the beneficiary or heir sells the property for $100,000, he or she will pay tax only on the $40,000 difference between the new basis ($60,000) and the selling price ($100,000).

This is a simplified explanation and is not meant to replace tax advice. If you intend to sell inherited property, you should talk to a probate lawyer, a tax lawyer or a certified public accountant.

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How does the Alaska Community Property Act affect the federal income tax basis of property that is inherited from the person who died?

In Alaska, spouses can choose to treat property as community property by creating a special agreement or trust under the Alaska Community Property Act. Community property can have tax benefits when the property is sold after one spouse dies.

When two spouses own property together, only the tax basis in the part owned by the spouse who died (usually one-half) is adjusted to the value at the date of the first spouse's death. But if the property is community property, the tax basis of the entire property is adjusted to the value at the date of the first spouse's death.

For example, if spouses own a parcel of land together, paid $10,000 for the parcel and sold it for $100,000, they must pay tax on the $90,000 difference between the cost basis ($10,000) and the selling price ($100,000). If one spouse dies when the property is worth $60,000, one-half of the tax basis in the property (the deceased spouse's half) is increased to $30,000. The other half remains at $5,000. The combined basis is $35,000. Tax is due on the $65,000 difference between the new basis ($35,000) and the selling price ($100,000). But if the property is community property, the tax basis in the entire property is increased to $60,000. Tax is due only on the $40,000 difference between the new basis ($60,000) and the selling price ($100,000).

This is a simplified explanation and is not meant to replace tax advice. If the person who died owned any community property, you should talk to a probate lawyer, a tax lawyer or a certified public accountant.

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Where can I learn more about the different tasks for Personal Representatives?

You can learn more about the:

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Rev. 21 July 2014
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