Estate Planning

Income Taxation of Estates - a Brief Overview

By Greg Herman-Giddens

In North Carolina it is not uncommon for persons to handle administration of a decedent's estate without hiring a lawyer or an accountant.  Because of the complexity of the law and the likelihood that certain requirements or opportunities will be overlooked, I certainly don't recommend going it alone.  This post is not intended to be a do-it-yourself guide, but simply an overview of the basic process.  Complying with income tax requirements is the most complex part of the majority of estates.

A deceased individual's tax year ends as of the date of death.  Thus, all of the items of income and deduction prior to that date are reported on Form 1040.  The tax year for the estate begins on the date of death, and generally ends on the last day of the month 11 months later.  A separate tax id number for the estate is necessary and must be obtained from the IRS.  The tax id number is provided to all financial institutions in which the decedent owned an account for income reporting purposes, and is used for the estate checking account.

Estates report interest, dividends and capital gains just as individuals do, but IRS Form 1041, the tax return for estates and trusts, is significantly different form Form 1040.  The top federal rate of 35% (for 2010) is reached at just $11,200 of taxable income, versus about $373,000 for individuals.  However, to the extent there are distributions to the beneficiaries in a taxable year of the estate (except for distributions of specific amount or assets per the terms of the will), net income is "carried out" and is reported as income to the beneficiaries on Schedule K-1.  Capital gain is generally taxed to the estate.

Certain expenses can be deducted on the 1041, such as attorneys and accountants fees, executor's commissions, court fees, appraisals and bank charges.  Funeral expenses and debts of the decedent are not deductible.

On the final return, if there is a net loss, the loss can be carried out to the beneficiaries.  On all but the final return, a $600 exemption is allowed.

The North Carolina income tax return for estates, D-407, uses information from the federal return in the manner of the NC individual return, D-400, does.

Taxation of trusts is similar, but there are a few differences.  The returns for estates and a decedent's living trust can be combined by filing a special election form.

Finally, the federal and North Carolina estate taxes are a completely different topic.  This year there is no estate tax, but it will return in 2011.

Full post as published by North Carolina Estate Planning Blog on January 30, 2010 (boomark / email).