As Benjamin Franklin said, “In this world, nothing is certain but death and taxes.” The fiduciary of an estate must deal with both. Whether the fiduciary is an Executor (with a will), an Administrator (without a will) or a Trustee (with a trust), he is responsible not only for marshalling the assets, paying the bills and distributing to beneficiaries, but for filing a variety of tax returns as well.
Two types of tax returns may need to be prepared. Inheritance taxes are paid on the assets that are transferred to the beneficiaries. Income taxes are paid on income received such as earned income, income from dividends, interest, qualified annuities, 401Ks, IRAs etc.
Inheritance Taxes. Inheritance taxes are paid at both the federal and state levels on net assets passed to beneficiaries. Federal Gift and Estate Tax is paid on estates of more than $3.5 million. Ohio taxes estates greater than $338,333. Inheritance taxes are calculated based not only on assets that pass though probate, but also on assets that pass by a trust, pass to a designated beneficiary or are held jointly with right of survivorship. This includes IRAs, annuities, and certain life insurance policies. Inheritance taxes may also be charged on assets that the decedent transferred less than three years before his death and on those in which he kept some interest, such as life estates or certain irrevocable trusts.
Sometimes it is necessary to file an inheritance tax return even when there is no tax due. For example, tax is not charged on distributions made to the surviving spouse, but if the gross estate exceeds the taxable amount, a tax return must be filed none-the-less. Similarly, if the gross estate is large, but the expenses bring the net estate below a taxable level, the return must still be filed. If there is real estate of any value, an Ohio estate tax return should be filed to clear the title even if no tax is due.
Income Taxes. The fiduciary is responsible for filing the decedent’s final income tax returns (federal, state, city) and, if the decedent owned a business, may be responsible for those returns as well. The final personal income tax should include any income received under the decedent’s social security number.
The estate is considered a separate entity from either the decedent or the fiduciary. It requires its own tax number. The fiduciary must secure a separate tax number (EIN) to use for accounts established in the name of the estate. Similarly, when someone other than the grantor takes over as the trustee of a trust, a new tax number (EIN) is required.
Any income received under the EIN must be reported on a separate tax return. If the estate or trust is closed and assets are distributed prior to the tax being due, the fiduciary can pass the income on to the beneficiaries in proportion to their shares. The beneficiaries will then report their portion of the income on their individual tax returns.
Sometimes there is no income received under the EIN. Perhaps the funds were kept in a non-interest bearing account. If the estate is closed with no income, the EIN can be cancelled with no tax return having been filed. Of course, estates which have income and remain open must file an income tax return each year.
It is important for the fiduciary to file tax returns when they are due to avoid penalties and interest. The assistance of an attorney or accountant is deductible as an expense of the estate.