Dealing with the Death of a Loved One and Related Tax Implications

October 30, 2015 : H&R Block

day of the dead painted skulls

November 1 is the celebration of Day of the Dead, or Día de los Muertos. It’s the time of year in the Latino culture that we commemorate the history and memory of our ancestors.

As we recall those who have died, it’s also a good time to call to mind the responsibilities of the ancestors who are left to care for the deceased’s affairs. The last thing on your mind is probably taxes. However, even death has tax implications you should consider if a loved one recently passed away.

I asked Ashlee Crowl of the Tax Institute at H&R Block to help answer some of the common tax questions that come up when we face the death of a loved one.

When a loved one passes away, when does the person who survived the deceased know that they need to file a tax return?

AC: The first thing to know is that filing a tax return is the responsibility of the personal representative. That may be the estate executor or administrator, the surviving spouse, a legal representative or anyone in charge of the decedent’s property. The personal representative must file the final income tax return (Form 1040) of the decedent for the year of death and any returns not yet filed for preceding years. For the year of death, the Form 1040 includes income and expenses up until the date of death.

Upon a person’s death, does the personal representative also have to pay estate taxes and file income tax returns for the estate?

AC: The personal representative of a large estate may need to file a federal estate tax return (Form 706). If the decedent is a U.S. citizen or resident, an estate tax return (IRS Form 706), is usually only required if the value of the decedent’s gross estate, plus taxable lifetime gifts, is more than the basic federal estate tax exclusion amount.

So what does that mean? First, the gross estate is all of the property the decedent owned including cash, amounts in bank accounts, investments, real estate, life insurance, vehicles, retirement accounts, business interests, and other personal property. For individuals who died in 2015, an estate tax return only needs to be filed if the amount of those assets is $5,430,000 or more.

A federal income tax return (Form 1041) will need to be filed in the first year (starting at death) and may need to be filed in subsequent years if the gross income of the decedent’s estate is $600 or more, or if there is a beneficiary who is a nonresident alien.

What about the tax implications if you received an inheritance?

AC: Generally, amounts received as an inheritance are excluded from gross income for federal income tax purposes. However, if inherited property later produces income such as interest, dividends or rents, that income is taxable to the person who inherited the property. This includes income from property that is given to a trust or held in an estate and paid or distributed to a beneficiary.

Special rules may apply in the case of items that are considered income in respect of a decedent (IRD). IRD is income that was earned by the individual but not paid until after the person died. These amounts are taxable to the beneficiary in the year the amounts are received.

Certain states still impose an inheritance tax, which could require an individual receiving property to pay tax on amounts received from a decedent. However, most states no longer impose an inheritance tax.

What if you received a payment from a life insurance policy?

AC: When a beneficiary receives proceeds from a decedent’s life insurance policy because the insured person died, those proceeds are not included in that beneficiary’s income when received as a lump sum. There are special rules if the beneficiary received the policy in installments.

There are many more complicated tax issues – what if you receive a payment from the deceased’s retirement account? What if your loved one was in debt when they died? How are those amounts treated? For more in-depth answers to these questions, that are specific to your situation, make an appointment to talk with one of our tax professionals.

We wish you a joyful Día de los Muertos, to celebrate the lives of all those family members and loved ones who have died. Their impact on your life will be felt in many ways – emotional, spiritual and even financial. Hopefully, this information can help a bit in the last regard.

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