Personal and Estate Income Tax
Part four of this series covered the executor’s duty to ascertain and discharge the debt obligations of the deceased.
This part of the series will cover the executor’s duty to ensure that the deceased’s and estate’s tax matters are in compliance with current tax rules.
If there was any doubt until now, on whether the executor should retain the services of estate professionals, it should be put to rest at this point because it is critical to retain the services of a skilled accountant who is well versed and experienced in tax matters relating to deceased individuals and estates.
It is common after the death of an individual for the executor to seek out and retain the accountant who historically prepared the deceased’s personal tax returns in order to also prepare the deceased’s final income tax return. This potentially is a mistake. The executor should undertake a due diligence interview process to choose the suitable accountant.
The accountant retained should have a strong familiarity with tax issues relating to final income tax filings as well as estate tax filings. For example, he or she should have a solid experience in: a) the various tax filings available for a deceased person, b) the tax rules specific to the death of taxpayer, c) the elections that may be available for a deceased individual, and d) current tax rules relating to testamentary estates.
Much is at stake here for the executor as he or she is personally liable for any of the deceased’s unpaid personal taxes and unpaid taxes owed by the deceased’s estate.
Here are some issues the executor should consider and discuss with the accountant who will be assisting with tax compliance matters:
1. Personal tax return for the prior year and for years that are in-arrears: The executor should ensure that all tax filings are up to date and current, and that a tax return is prepared and filed for any prior year for which a tax return has not been filed. Furthermore, paying any assessed arrears penalties, interest and outstanding tax balances.
2.Final tax return: This tax return is the last personal tax return for the deceased and is for the period from January 1 in the year the death occurred to the date of death. There are specific rules for the filing deadline for this tax return. This tax return is different from the historical tax returns in that there are special rules that apply to the final tax return.
As stated previously, these may include various tax filings available, tax rules specific to the death of taxpayer such as the deemed disposition of assets and reporting of capital gains and losses, and elections that may be available such as electing on a rollover to a surviving spouse at fair market value instead of at cost in order to trigger capital losses that can offset other capital gains. When it comes to compiling the information and documents necessary for the preparation of this tax return, a good starting point would be to read Part IV of this series (“Taking Inventory of Estate Assets”).
The asset inventory list the executor compiles will provide a good indication of the various sources of the income that is anticipated to be reported on the final tax return.
3.U.S. estate tax: The executor should determine if the deceased owned any assets that are located or deemed to be located in the United States, ascertain the market value of these assets at the date of death, and contact a U.S. tax specialist to determine if any U.S. tax filings are required and whether there is U.S. estate tax payable.
4. Estate tax returns: From a tax perspective, there is a continuity of events after the date of death whereby a new tax entity is born. The deceased’s estate, which is referred to as a testamentary estate because it came to be as a result of the death of an individual.
There are specific tax rules relating to testamentary estates the accountant hired by the executor should be well-informed of the current tax rules in this area. An estate tax return should be filed yearly until such time that the estate is wound-up. If the income generated by the estate needs to be allocated to beneficiaries on a yearly basis, the executor should ensure to undertake the proper tax reporting to the beneficiaries.
5. Clearance certificate: Once the executor has filed all personal and estate tax returns and all returns have been assessed and all taxes paid, the executor should file a request with the tax authorities for a clearance certificate. This should be done prior to distributing the estate residue to beneficiaries.
The request should be made for the date of death as well as the wind-up date of the estate. When the tax authorities receive the request, they will proceed with their own due diligence process to ensure all taxes have been paid or sufficient security has been obtained. Upon completion of this process, the tax authorities will issue a clearance certificate naming the executor and relieving him or her from liability for any unpaid taxes.
Stay tuned for part six of this series in which I will discuss issues relating to administrating and maintaining the estate.