Posted by Jordon Rosen, CPA, MST, AEP®
There are several tax elections and planning opportunities that I find are frequently overlooked by executors and tax return preparers when filing a decedent’s final income tax return. The first mistake commonly made is identifying the decedent’s taxable year. For a calendar year taxpayer, the tax year begins on January 1 and ends with the date of death (not the day before). Even if the decedent passed at 2AM and an unknowing broker sold stock for a gain at 10AM, the transaction is reported on Schedule D of the decedent’s final Form 1040, without any step-up in basis.
Filing Status: In most cases, married couples are better off filing a joint tax return. However, if the decedent had high medical expenses and relatively low income, filing separate returns would yield a larger medical deduction since there is a 10% of AGI floor for deducting medical expenses, which would be reduced by adding the surviving spouse’s income to AGI on a joint return.
Medical Expenses: Section 213(c) of the Internal Revenue Code allows the executor to deduct medical expenses on the decedent’s final income tax return for the year the expenses were incurred if paid by the estate within one year of death. The election must be filed in duplicate with the tax return and include a statement that the same expenses were not taken as a deduction against the gross estate.
Series E/EE Bonds: The executor can elect under Section 454(a) to include all previously accrued but unreported Series E/EE U.S. Bond interest through the date of death on the decedent’s final return. This interest would otherwise be considered income with respect to a decedent and be taxed to the beneficiary, who may be in a much higher tax bracket than the decedent. This works well if the decedent dies early on in the year with little income or has large deductions or losses to offset the interest.
Losses: Most losses die with the taxpayer. This includes any unused net operating losses and capital losses in excess of the allowable $3,000 limit. A surviving spouse cannot carry over excess capital losses attributable to the decedent beyond the final tax year of the decedent. If the account that produced the excess capital loss was a joint account, the surviving spouse could possibly make a claim for carrying over half of the excess losses, although this is unclear. Where the decedent has accumulated unused passive losses, such losses are deductible on the decedent’s final return only to the extent, if any, the losses exceed any step-up in basis attributed to the asset/activity that is being transferred by reason of the death of the decedent.
Installment Sales: If the decedent had entered into an installment sale before death, the executor can elect out of the installment sale method by reporting the entire proceeds from the sale on the decedent’s final income tax return.
If you have questions or want further information on the above or other income, retirement or estate planning techniques, please contact Jordon Rosen at email@example.com.