What exactly is an estate income tax return?

As I sit by my father’s side in Arizona for his final days, thinking of a topic for this week’s article, the impending need for me to prepare an estate income tax return seemed like an appropriate topic to discuss. There are potentially two types of tax returns that need to be filed and corresponding taxes owed upon the death of an individual.

The first is called the estate tax. This is the tax due on the transfer of assets from the decedent to their beneficiaries and heirs as a result of their death. This specific tax impacts very few individuals as the current estate tax exemption is $11,700,000 per person. Although I have a couple of clients who have estates that are greater than this exemption amount, I have never actually prepared one of these returns. Typically for the few times this type of return would need to be prepared, an estate attorney is involved and much planning has taken place to reduce this tax obligation while the individual is still alive.

The more common type of tax return related to a decedent is the estate income tax return.

When someone dies, their assets become property of their estate. Any income those assets generate is also part of the estate and may trigger the requirement to file an estate income tax return. Examples of assets that would generate income to the decedent’s estate include savings accounts, CDs, stocks, bonds, mutual funds and rental property. IRS Form 1041, US Return for Estates and Trusts is required if the estate generates more than $600 in annual gross income.

The decedent and their estate are separate taxable entities. Before filing Form 1041, you will need to obtain a tax ID number for the estate. An estate’s tax ID number is called an “employer identification number,” or EIN, and comes in the format 12-345678X. You can apply online for this number. You can also apply by fax or mail, although online is generally the fastest and my preferred method.

A decedent’s estate figures its gross income in much the same manner as an individual. Most deductions and credits allowed to individuals are also allowed to estates and trusts. However, there is one major distinction. A trust or decedent’s estate is allowed an income distribution deduction for distributions to beneficiaries. Income distributions are reported to beneficiaries and the IRS on Schedules K-1 (Form 1041).

For calendar year estates and trusts, file Form 1041 and Schedule(s) K-1 on or before April 15 of the following year. For fiscal year estates and trusts, file Form 1041 by the 15th day of the fourth month following the close of the tax year. If more time is needed to file the estate return, apply for an automatic five-month extension using IRS Form 7004, Application for Automatic Extension of Time to File Certain Business Income Tax, Information, and Other Returns.

This estate income tax return needs to be filed each year until the estate is settled and the assets are disbursed to the respective beneficiaries.

In many cases there is only one estate income tax return that needs to be filed if the estate can be settled within the first year after the taxpayer has deceased. The simpler the estate and the less contentious the beneficiaries are can certainly speed the process of settling the estate and reduce the number of estate income returns that ultimately need to be filed.

As the saying goes, the only things certain are death and taxes. Having a good record of the assets and good contact information for the beneficiaries, as well as a solid understanding the wishes of the decedent can certainly make this unfortunate process simpler and less stressful.