Why Does an Estate Need to File an Income Tax Return?

We have many clients ask us why an estate must file an income tax return. The quick answer requires you to understand a simple concept that may come as a surprise. When someone dies, the assets they own create an “estate” which may be made up of income producing property and non-income producing property. The IRS has created rules which state that the estate is now a new, separate taxable entity. It is possible for an estate to receive income following an individual’s death. Someone has to pay taxes on that income so the estate has to file an income tax return.

Common examples include income from a business, rental property, dividends, or even the interest that accrues on the deceased’s checking or bank accounts. All of these are considered to be income from the Internal Revenue Service (IRS). You should also understand that an estate’s income taxes are different from estate taxes, which are based upon the value of the estate.

If an estate receives income after the individual dies and before the estate property has been distributed, it must be reported to the IRS. The appropriate form for reporting an estate’s income is Fiduciary Income Tax Return or Form 1041. If a beneficiary inherits an asset directly from the deceased, the estate does not have to report income on that asset. The beneficiary reports income from the date of death. For example if you inherited General Motors stock because of joint ownership, any dividends paid from the date of death must be reported by you.

In addition, if the estate earns income on certain assets, but then makes distributions to beneficiaries, the estate reports the income, but the beneficiaries may have to report it on their individual income tax returns and pay tax on the income.

Is it possible to avoid the fiduciary income tax? With our help and careful planning, it may not be necessary for a fiduciary income tax return to be filed. If all of the estate assets are quickly transferred to your beneficiaries, the estate will likely not hold the property long enough to earn enough income to require filing of a return. For example, assets that are held in a trust are generally distributed quickly, which can help minimize tax consequences. In contrast, if the probate process is delayed by family disputes or legal issues, the distribution of the estate assets can be delayed for months, even longer! As a result, the estate ends up holding the assets for a period of time, the estate receives income, and that results in the need for the estate to file an income tax return.

We can help trustees or executors understand the tax reporting rules and avoid tax reporting under the right circumstances.

The Astill Law Office has provided high quality legal services for over 30 years. We specialize in wills, trusts, estate planning, and asset protection. If you have any questions about creating a Trust, Will, or estate planning in general, contact The Astill Law Office at 801-438-8698.