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When Your Client Dies: Final Form 1040, Post‐Death Elections and More

[webinar Title] 2©2021, CCH Incorporated. All Rights Reserved.

When Your Client Dies:Final Form 1040, Post‐Death Elections and More

Steven G. Siegel, J.D., LL.M. (Taxation)

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3When Your Client Dies:

Final Form 1040, Post‐Death Elections and More

Discussion Topics

Preparing the Final Form 1040

• What Should be Filed and Reported

• Who Must File the Return

• Income, Losses and Deductions to be Reported

• Estimated Taxes, Liabilities and Refunds

• Income in Respect of a Decedent (IRD) Considerations



Discussion Topics

Elections and Decisions to Consider

• Alternate Valuation Date

• QTIP and QDOT Decisions for the Surviving Spouse

• Extending the Time to Pay the Federal Estate Tax (Code Sec. 6166)

• Elections for Partnerships and S Corporations

• Where and When to Deduct Fiduciary Commissions

• Fiscal Year Option for Estates

• Disclaimer Opportunities

• Treating a Revocable Trust as Part of the Estate

• Special Distribution Opportunities from an Estate

• Choices in Timing Charitable Deduction Claims

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The Final Income Tax Return for a Decedent



First Things First

• Final income tax return is due on April 15 of the year FOLLOWINGthe year of death

• Apply for a federal identification number for the estate as soon as possible using Form SS‐4, Application for Employer Identification Number

• File Form 56, Notice Concerning Fiduciary Relationship, with the IRS

• Final Tax Year ends with date of death

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Review Question 1



What to Include in the Final Tax Return

• Income through date of death

Actually received

Constructively received

Deductions appropriate through date of death

Medical, interest, charitable, etc.

State and local income and property tax – $10,000 cap for 2020 and 2021

Business expenditures

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Who Must FileJoint and Separate Return Issues

• Court appointed executor, administrator or personal representative is responsible for filing the decedent’s final income tax return, and signs for the decedent. If none appointed, spouse can act

• Joint return allowed if the surviving spouse HAS NOT remarried by the end of the year of the decedent’s death.

• If surviving spouse HAS remarried by the end of the year of decedent’s death, then no joint return can be filed and decedent’s return must be filed as married filing separately



Who Must FileJoint and Separate Return Issues

• Be aware that you may have to file two federal income tax returns

i.e., one for the year prior to the decedent’s death that was not filed by the decedent at the time of death, and the final return for the decedent’s actual year of death

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Labeling and Filing the Final Return

• Write “Deceased” and the decedent’s date of death across the top of the return and in the signature block

• Include “Deceased” and date of death in the name block on Form 1040



Where to File?

• The decedent’s final income tax return should be filed with the Internal Revenue Service Center where the person filing the return lives

If the personal representative and decedent reside in different regions of the country, select the Service Center which servesthe location of the personal representative

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Items of Income and Deduction



Special RulesDeceased S Corporation Shareholders

• What income do you report?

• Allocation choices: Hypothetical closing of the books at date of death (Shareholders must consent); or

• Allocation of entire year on per diem basis (Most common choice)

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Special RulesPartners in Partnerships and LLC Members

• The Regulations provide two methods for a partnership to determine the items attributable to the short tax year

First method involves an interim closing of the partnership’s books on the date of death

Second method involves the pro‐ration of partnership items realized for the entire tax year to the short tax year

• The choice of method to use may be addressed in the partnership agreement — or the remaining partners must reach an agreement on the proper method to use



Special RulesPartners and S Corporation Shareholders

Losses suspended by tax‐basis limitations are personal to the partner or shareholder and expire at death

Cannot be transferred to partner’s or shareholder’s estate or beneficiary

Passive activity losses (PALs) generally expire at death

• Exceptions:

Partner’s or Shareholder’s suspended PALs at death may be deductible on final 1040 only to extent the Partnership or S Corp PALs exceed step up in basis to fair market value

Losses are taken on final 1040 and do not transfer to beneficiaries

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Review Question 2



Special RulesTrust Income

Only actual distributions of trust income received by the decedent through the date of death are included in the final 1040.

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Special RulesWages and Salaries

• Only payments received prior to death are included on the final 1040

• Payments received after death are included in the 1041



Special RulesIRAs & Other Retirement Plan Distributions

• Only amounts received prior to death are included on the final 1040

• Amounts received after death are included on the 1041

• Beneficiary must take decedent’s Minimum Required Distribution, if any, for year of death if the decedent failed to take it

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Special RulesInstallment Sales

• Death is NOT a disposition of an installment obligation

• Unrealized gain is not included on the final 1040

• Report on Form 1041 for estate or trust



Special RulesPersonal Residence Sales

• Prior to death

$500,000 exclusion on joint return,

or

$250,000 exclusion on single return

• After death surviving spouse if not remarried:

Sold within two years of date of death

$500,000 exclusion

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Special RulesSeries EE Bonds

• Planning Point

Consider making the election to pay tax on the accrued income when income is low, or when deductible expenses are high and income is needed to absorb the expenses. IRC Section 454



Special RulesMedical Expense Deductions

• Both medical expenses paid in the decedent’s final tax year prior to death and medical expenses paid after, but within one year of death, may be deducted on the decedent’s final income tax return

They are not deductible on the estate’s income tax return (Form 1041)

They are deductible on the estate tax return (Form 706) as a claim against the estate

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Review Question 3



Special RulesLosses, Credits, and Other Deductions

• Losses die with the decedent

Capital loss carryovers

Net operating losses

Excess charitable contributions

• No unused deductions of the decedent are allowed to carry over to the Form 1041

• Use it or lose it

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Special RulesDividends

• If declared and paid prior to date of death, they are reported on the final 1040

• If declared before death but paid after the date of death, they are reported on the Form 1041



Estimated Taxes

After the death of a decedent, estimated tax payments are not required to be made to avoid underestimation penalties;

Careful if a surviving spouse must still make estimated payments.

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Tax Liabilities and Refunds

• The decedent’s income tax liability is a debt deductible for estate tax purposes

• If an income tax refund is due on a joint return, the refund should be allocated between the spouses based on their contribution to the income and deductions reported

• If an income tax refund is due on other than on a joint return, the decedent’s personal representative should file Form 1310 with Form 1040 to claim the refund



Careful with 1099s and Other Information Forms for the Year of Death

• It is not unusual to receive 1099s, W‐2s and other information reporting forms that report more income than the decedent received prior to death

• Concerns with likelihood of mismatching

• The best way to address this problem is to report on the decedent’s final Form 1040 all of the income reported to the decedent under the decedent’s Social Security number for the tax year of death, and then show a subtraction on Form 1040

• Do not file Form 1040 for the decedent for the year following the year of death regardless of the SS# shown— file Form 1041 with statement attached

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Income and Deductions in Respect of a Decedent Issues

• A person may die with various rights and claims to income that have not yet been received

• IRD typically arises when a taxpayer derives income from one of several sources, including:

• Retirement plans, installment sales, deferred compensation

• IRD Problem: No basis adjustment to date of death value


Elections that Affect the Fiduciary Income Tax Return

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Selection of a Fiscal Year

• An estate has the option of choosing to report its income on a fiscal reporting year, so long as the year ends on the last day of a month

• The estate selects its fiscal year when it files its first federal income tax return adopting that year

• Beneficiaries report their shares of income from an estate in their tax years with or within which the estate tax year ends

• Consider the adoption of a fiscal year for an estate



The Qualified Revocable Trust ElectionCode Section 645

• The executor of an estate and the trustee of a “qualified revocable trust” (QRT) can elect to treat the decedent’s revocable trust as part of the estate rather than as a separate trust for income tax purposes

• The term “qualified revocable trust” refers to any trust that was treated as owned by the decedent at death as the result of the decedent retaining a power to revoke the trust under Code Section 676

• If no estate tax return is filed for the decedent’s estate, this election applies for two years from the date of the decedent’s death

• There are a number of valuable benefits arising from making this election (Fiscal year choice; delayed estimated taxes; 1 return for the estate and trusts(s); $600 exemption as an estate; charitable set aside)

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Electing Where to Claim Estate Administration Expense Deductions

• Allowable estate administration expenses can be deducted on either the estate income tax return (Form 1041) or on the estate tax return (Form 706)

• Certain expenses incurred by an estate may only be deducted on Form 706 — and not on Form 1041

• Example: Funeral expenses

• Medical expenses of the decedent paid within one year of the decedent’s death may be claimed on either the decedent’s final Form 1040 or on Form 706, but may not be claimed on Form 1041



The 65‐Day Election for Distribution Allocations

• Estates and trusts may elect to treat all or part of distributions made to beneficiaries within the first 65 days of the taxable year as if they were paid on the last day of the preceding taxable year

• The election is made by having the fiduciary simply check the appropriate box on Page 3 of Form 1041

• Use this election to reduce the bracket in which the income may be taxed

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Estimated Tax Payment Elections

• A trust is required to make annual payments of estimated taxes and can elect to treat any portion of the estimated taxes it has paid as made instead by a trust beneficiary

Election is made by completing Form 1041‐T and filing within 65 days after the end of the trust’s taxable year

Election applies to estimated taxes paid by the trust for any tax year and by the estate only in its final year



Election to Deduct a Charitable Contribution on the Prior Year’s Tax Return

• A trust and an estate have the opportunity to elect to deduct a charitable contribution made in one year on the income tax return for the prior tax year

• A situation could arise where there is insufficient taxable income in a particular year to utilize the benefit of the charitable deduction

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Election to Recognize Gain on the Distribution of Property

• As a general rule, an in‐kind distribution of property by an estate or trust to its beneficiaries does not result in the recognition of gain or loss to the distributing entity. The entity’s basis carries over

• A special election is available to enable the estate or trust to treat the property distribution as a sale of the property at its fair market value, and recognize the gain at the level of the trust or estate. That can get a higher basis to the entity

Careful of the Net Investment Income Tax thresholds here

• The distribution of property carries out DNI to the beneficiaries, but the amount of DNI depends on whether or not the Section 643(e) election was made



Addressing the Final Year of the Trust or Estate

• In the year of termination of the trust or estate, the unused capital losses and net operating losses of the entity may be passed through to the beneficiaries.

• If there are excess deductions for the year of termination, certain deductions may be passed to beneficiaries and deducted by them; others are considered miscellaneous itemized deductions and may no longer be available to be claimed by the beneficiaries IR 2020‐90 (5/7/20).

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Addressing the Final Year of the Trust or Estate

• Distinguish expenses commonly or not commonly incurred in trust or estate context.

• Ownership costs, Investment advisory fees – NOT allowed. (Knight v. Commissioner).

• Tax preparation fees, appraisals, probate fees, accountings, bond premiums – ARE allowed.

• Bundled trustee fees – Allocation may be required.

• Passive losses incurred by the estate or trust do not carryover to the beneficiaries, except as basis adjustments.



Review Question 4

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Disclaimers



What Is a Disclaimer?

• A disclaimer is an act by a beneficiary whereby the beneficiary declines, refuses and renounces an interest in property otherwise bequeathed to the beneficiary

• Where a disclaimer satisfies the requirements of a “qualified disclaimer,” the disclaiming beneficiary is treated as not having made a gift

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Requirements for a Qualified Disclaimer

• Code Section 2518 contains the requirements for a qualified disclaimer, effective for all transfers made after 1977

• These include the following

Must be in writing

Must be unqualified and irrevocable

Must be signed

Must identify the interest disclaimed

Must be delivered to the personal representative of the estate or to the transferor of the property or to the holder of legal title to the property within nine months after the creation of the instrument

The nine‐month period commences with the “transfer creating the interest”

For transfers made during lifetime, the period begins when the transfer is complete for federal gift tax purposes



Requirements for a Qualified Disclaimer

For transfers made at death, or that become irrevocable at death, the decedent’s date of death is the date from which the nine‐month period is measured

The timing requirements provided under federal law are intended to create a uniform standard for federal law purposes, notwithstanding whether or not a disclaimer will be considered timely as a matter of state law

– Extending the time to file the federal estate tax return does not extend the time to make a qualified disclaimer

• The person disclaiming must not accept the property interest or any of its benefits prior to the disclaimer

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Interests in Jointly Held Property May be Disclaimed by the Surviving Joint Tenant

• May be used to overcome the failure of a married couple to adequately separate their assets during lifetime, so as to be able to take full advantage of the applicable exclusion available at the death of the first of the spouses to die

• The Regulations adopted the general rule that transfers must be disclaimed within nine months from the date of the transfer creating the disclaimed interest

• Joint accounts (such as bank accounts, brokerage accounts, mutual funds, and other investment accounts) that are revocable during the decedent’s lifetime may be disclaimed in their entirety by the surviving joint tenant within nine months of the death of the deceased co‐tenant


Code Section 6166 Installment Payments

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Liquidity Concerns

Recognizing that closely held businesses are likely to face serious liquidity problems — and attempting to create a relief provision to make it unnecessary to sell the business interest to pay death taxes (which are due nine months from the date of the decedent’s death), Congress enacted a provision to permit the deferral of estate tax payments (Code Section 6166)



Criteria for Availability

• Only available if decedent was a U.S. citizen or resident at the time of death, and

• Value of the decedent’s interest in a closely held business must exceed 35% of the value of the decedent’s adjusted gross estate to be eligible

• The Section 6166 election must be made on Form 706

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Tax Payment Deferral OpportunityWhich Business Interests Are Taken into Account

• If the criteria are met, the portion of the estate taxes attributable to the closely held business interest can be deferred completely for five years and thereafter paid in up to 10 annual installments. Interest only is due for the 1st 5 years of deferral

• The estate tax attributable to non‐closely held business assets is due at the regular time i.e., nine months from the decedent’s date of death

• Multiple businesses can be aggregated to meet the 35% test – if decedent owned at least 20% of the business

• No passive business interests can be included



Interest Obligation on the Deferred Payments

• Interest rate is 2% for interest payable on the deferred tax attributable to the first $1 million in taxable value of a closely held business

• The $1 million is indexed annually for inflation for decedents dying after 1998

It is $1,570,000 for 2020 and $1,590,000 for 2021

• Interest on the deferred tax in excess of the 2% portion is payable at a rate equal to 45% of the annual underpayment rate established under Code Section 6621

• Interest begins to run as of the due date of the tax payments and is payable annually

• Tax can be prepaid at any time without penalty

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No Deduction of Interest Payments

• Interest payments made by the estate are not deductible as an estate administration expense for estate tax purposes

• Interest payments made by the estate are not deductible for income tax purposes



Acceleration of Balance of Tax Due

Acceleration of the installment payments due date will occur if certain prohibited events take place, i.e., failure to pay the required installments or sale of more than 50% of the business

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Marital Deduction Planning



The Portability Election

• Be sure to address portability. The unused exclusion of a deceased spouse (“DSUE”)may be available to the surviving spouse.

• File a timely Form 706 to make the necessary election.

• The 706 may be filed within 2 years of the decedent’s death. Rev. Proc. 2017‐34. If filing later, private letter ruling and a user fee may be required. The user fee is now $12,600.

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Review Question 5



Marital Deduction Election General Rules

• Typical estate planning for married couples suggests use of the estate tax marital deduction at the death of the first spouse to die

• When property is left in trust by a decedent for his or her surviving spouse, such a conveyance may qualify for the estate tax marital deduction if the trust is written in a qualifying manner, if certain mandatory requirements are observed, and if the personal representative of the first decedent’s estate makes a qualifying election

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QTIP Marital Deduction Election General Rules

• In order to satisfy the QTIP requirements, the surviving spouse must be given a qualifying income interest for life in the QTIP property

• The QTIP election must be made on a timely filed estate tax return (including extensions) or on the first return following the due date if a timely return is not filed



QTIP Marital Deduction Election

• The effect of the QTIP election is to defer estate tax liability from the death of the first spouse until the death of the surviving spouse – resulting in inclusion of the property in the estate of the second decedent – but also a fair market value basis at the second death

• Possibly the “ideal” planning choice for the “blended family”

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Preserve Marital Deduction for Non‐Citizen Spouses with QDOT Election

• The marital deduction is disallowed where the surviving spouse is not a United States citizen

Exception

• Surviving spouse becomes a U.S. citizen before the estate tax return is filed provided he or she was a U.S. resident at all times after the date of decedent’s death and before becoming a U.S. citizen

• The marital deduction will apply, even if the spouse is not a U.S. citizen, where the property passes to a Qualified Domestic Trust (QDOT)


Electing the Alternate Valuation Date

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Electing the Alternate Valuation Date• An estate has the option to report the value of the decedent’s

assets as of the date of death or as of the date that is six months after the decedent’s date of death

• In order for the alternate valuation date election to be permitted to be used, the gross estate must decline in value and the combined estate and generation‐skipping tax liability must decline as the result of making the election

• The alternate valuation date election is irrevocable once made

It must be made by checking a box on Form 706 and completing the Form indicating the alternate valuation information where appropriate

• For assets sold or distributed after the decedent’s date of death and before the six‐month alternate date, the value used is the value of the asset on the date of sale or distribution


Electing Special Use Valuation for Real Property Used in Farming or Closely Held Businesses

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Technical Requirements to Qualify for Election

• The decedent must have been a U.S. citizen or resident at the time of his or her death

• The real property must be considered “qualified real property”

Maximum value reduction for 2020: $1,180,000. It is $1,190,000 for 2021

• 50 percent or more of the adjusted value of the gross estate must consist of real or personal property which was being used for a qualified use by the decedent or a member of his or her family on the date of the decedent’s death and which was acquired from or passed from the decedent to a qualified heir of the decedent



Technical Requirements to Qualify for Election

• The decedent or family members must show “material participation” in the property.

• Qualified use must be shown for at least 5 of the 8 years prior to death.

• Failure of the heirs to maintain the qualified use for 10 years results in recapture of the tax benefit.

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Section 754 Election to Adjust the Basis of Partnership Assets




• The death of a partner results in the basis of the partner’s interest in the partnership being adjusted to its fair market value on the date of the partner’s death, or the alternate valuation date if elected

• A Section 754 election may be made by the partnership to allow the partnership to adjust the inside basis of its assets (under Code Section 743(b)) to the fair market value of the partnership interest upon either the sale or exchange of an interest in the partnership, a distribution to a partner, or upon the death of a partner

• Election is irrevocable once made; applies to all future years

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• The Section 754 election is made by the partnership by attaching a statement to its Form 1065 by the due date (including extensions) or within 12 months thereof for the year during which the partner died (or a partnership interest is sold)

• The “downside” to the tax benefits offered by a Section 754 election is the additional costs and administrative burdens of computing and tracking the basis adjustments applicable to every item of partnership property, as Section 754 requires


Special Elections to Protect a Corporation’s S Corporation Election

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• When a shareholder of an S corporation dies, the corporation is at risk that the decedent’s S corporation shares may be transferred to an ineligible shareholder, thus jeopardizing the continued viability of the S election

• When S corporation stock is transferred to a trust, the trust must be an eligible S corporation shareholder

The trust must be either a Qualified Subchapter S Trust (QSST) or an Electing Small Business Trust (ESBT)




• An election is required to allow S corporation treatment to continue – to be filed within 2.5 months of the trust becoming a shareholder of the S Corporation

• A QSST may only have a single current‐income beneficiary who must be a United States citizen or resident

• An ESBT may have multiple beneficiaries and is permitted to either distribute or retain its income in the discretion of the trustee (including allowing nonresident aliens as potential beneficiaries after the 2017 Act)

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Rev. Proc. 2013‐30 Provides Relief from Failure to File Elections

• Request must be made within 3 years and 75 days of the required effective date for the proper election

• Consistent S corp. treatment must have been followed despite no election; timely return filing required

• Reasonable cause required

• Avoids private letter ruling requirement



Review Question 6

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Thank You for Attending Today’s Program



Final Exam

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