Losing a loved one is not only emotionally devastating but can also bring unexpected financial challenges.
The Consumer Awareness and Preferences Study from the National Funeral Directors Association (NFDA) found that while 62.5% of respondents believe it is crucial to discuss funeral plans and wishes with family before passing, only 21.4% had done so.
This gap between consumer attitudes and actions regarding funeral preplanning has persisted as a key trend over the past five years.
With complex tax implications and time-sensitive deadlines, navigating the fiscal aftermath of a loss can be overwhelming.
Here are the ten crucial tax tips that will help you confidently manage finances after a death in the family, ensuring you don’t miss out on potential savings or fall into costly pitfalls.
1. File the final individual tax return
When a loved one dies, their final individual tax return must be filed for the year of death. This return covers the period from January 1st until the date of death.
As the executor or surviving spouse, you’ll need to gather all relevant financial documents to report income and deductions for this period accurately.
It’s crucial to note that the filing deadline for the final return remains the same as for regular tax returns – typically April 15th of the following year. However, you can request an extension if you cannot file by the deadline.
Remember to write “DECEASED” across the top of the return, along with the decedent’s name and date of death, to ensure proper processing by the IRS.
2. Consider filing as a surviving spouse
For married couples, the year of a spouse’s death presents a unique tax situation. The surviving spouse can still file a joint return for that year, potentially benefiting from more favorable tax rates and a higher standard deduction.
This option is available even if the deceased spouse passed away on January 1st of the tax year.
Furthermore, for the two years following the year of death, the surviving spouse may be eligible to file as a qualifying widow(er) if they have a dependent child.
This status allows joint return tax rates and the full standard deduction, providing significant tax benefits during this transitional period2.
3. Understand the step-up in basis for inherited assets
One of the most important tax benefits for heirs is the step-up in basis for inherited assets. When someone inherits property, the tax basis of that property is generally “stepped up” to its fair market value at the date of the decedent’s death.
This can result in significant tax savings when the heir sells the inherited asset.
For example, if your loved one purchased a house for $100,000 that was worth $300,000 at the time of their death, your new tax basis would be $300,000. If you later sell the house for $320,000, you would only owe capital gains tax on the $20,000 difference, not the full $220,000 appreciation.
This rule applies to most inherited assets, including stocks, bonds, and real estate, making it a crucial consideration in estate planning and tax management.
4. Be aware of estate tax exemptions
While dealing with estate taxes may seem intimidating, it’s important to understand that most estates won’t owe federal estate tax.
The federal estate tax exemption for 2024 is quite generous, allowing estates to pass on significant wealth tax-free. However, it’s still crucial to calculate the gross estate value accurately to determine if any estate tax is due.
If the estate’s value exceeds the exemption threshold, you must file Form 706 (United States Estate Tax Return) within nine months of the date of death. Remember that some states impose their own estate or inheritance taxes, often with lower exemption thresholds than the federal government.
Consulting with a tax professional can help you navigate these complex rules and ensure compliance with both federal and state requirements.
5. Claim applicable deductions on the estate tax return
When filing an estate tax return, don’t overlook potential deductions that can reduce the taxable estate value. Common deductions include funeral expenses, outstanding debts, and administrative costs for estate management.
Additionally, charitable contributions from the estate can be deducted, potentially lowering the tax burden.
One significant deduction to consider is the marital deduction. This allows unlimited assets to be transferred to a surviving spouse without incurring estate taxes.
However, it’s important to note that this deduction only postpones estate taxes until the surviving spouse’s death.
Proper estate planning can maximize the benefits of these deductions while ensuring long-term tax efficiency for beneficiaries.
6. Consider income in respect of a decedent (IRD)
Income in respect of a decedent (IRD) refers to income the deceased person earned but didn’t receive before death. This can include unpaid salary, bonuses, or retirement account distributions.
As an heir, you may be responsible for paying income tax on this money when you receive it.
However, there’s a silver lining. You can claim an income tax deduction for any estate tax paid on the IRD. This helps prevent double taxation and can result in significant tax savings.
It’s crucial to identify all potential sources of IRD and work with a tax professional to ensure you’re claiming all available deductions related to this income.
7. Handle retirement accounts correctly
Inherited retirement accounts require careful handling to avoid unnecessary tax consequences.
For non-spouse beneficiaries inheriting traditional IRAs or 401(k)s, the SECURE Act of 2019 introduced new rules requiring most beneficiaries to withdraw all funds within 10 years of the account owner’s death. (ref) This can have significant tax implications, as these distributions are generally taxable as ordinary income.
Surviving spouses have more flexibility. They can treat an inherited IRA as their own, potentially delaying distributions and associated taxes. Alternatively, they can take distributions as beneficiaries, which may allow for penalty-free withdrawals before age 59½.
The choice depends on individual circumstances, including age and financial needs. Consulting with a financial advisor can help determine the most tax-efficient strategy for managing inherited retirement accounts.
8. Utilize the deceased spouse’s unused exemption (DSUE)
For married couples, the deceased spouse’s unused exemption (DSUE) can be a valuable tool for estate tax planning. This provision allows the surviving spouse to use any unused portion of their deceased spouse’s federal estate tax exemption, effectively doubling the amount that can be passed on tax-free to heirs.
To take advantage of the DSUE, the executor of the deceased spouse’s estate must file an estate tax return (Form 706) within nine months of the date of death, even if no estate tax is due. This election, known as “portability,” can provide significant tax savings for larger estates.
However, it’s important to note that not all states recognize portability for their estate taxes, so state-specific rules should be considered in your overall estate planning strategy.
9. Be mindful of gift tax implications
While dealing with a loved one’s estate, you might consider distributing assets to beneficiaries. Understanding the gift tax rules is crucial to avoid unintended tax consequences.
As of 2024, you can give up to $18,000 per person annually without triggering gift tax reporting requirements. Amounts above this threshold count against your lifetime gift and estate tax exemption.
However, certain gifts are exempt from gift tax altogether. These include gifts to your spouse, gifts to qualified charitable organizations, and direct payments of tuition or medical expenses for someone else.
By strategically using these exemptions, you can potentially reduce the overall estate value subject to estate tax while providing for your beneficiaries.
10. Seek professional help
Navigating the complex world of taxes after a loved one’s death can be overwhelming, especially while dealing with grief. Enlisting the help of tax professionals, estate attorneys, and financial advisors can provide invaluable guidance and ensure you’re making informed decisions.
These experts can help you identify tax-saving opportunities, avoid costly mistakes, and ensure compliance with all relevant tax laws.
Remember, every estate is unique, and tax laws can change. What worked for one family may not be the best approach for another. Professional advisors can tailor their recommendations to your specific situation, helping you honor your loved one’s wishes while minimizing tax burdens.
Don’t hesitate to seek help—it’s an investment that can pay dividends in peace of mind and financial savings during this challenging time.
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Nancy Maffia
Nancy received a bachelor’s in biology from Elmira College and a master’s degree in horticulture and communications from the University of Kentucky. Worked in plant taxonomy at the University of Florida and the L. H. Bailey Hortorium at Cornell University, and wrote and edited gardening books at Rodale Press in Emmaus, PA. Her interests are plant identification, gardening, hiking, and reading.
