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Chris Jones: Keys to Understanding Federal Estate Taxes

Federal and state taxes are important factors to consider when administrating a trust, going through probate court, or in any stage of the estate planning process.

Taxes are so important that even the idea of an estate exists largely for taxation purposes. After all, as the name implies, only the “taxable estate” is subject to taxation after death.

For your estate to survive the probate process intact, you must understand your taxable estate and how to protect it.

Value of the Taxable Estate

If you are a recently appointed successor trustee or executor, or if you have an interest as a beneficiary or other interested party to an estate, then you must become aware that settling the estate may require filing a federal estate tax return.

This filing requirement only applies to estates valued at over a certain amount of money, but that amount (and the total estate tax liability) will also depend on the laws in your particular state. Every state may have its own set of rules, regulations and procedures for settling the taxable estate.

These procedures are likely to be different from the procedures that govern the settling of the probate estate, which deals with the transfer of title to the assets. Though researching all of these rules and procedures is tedious, the parties responsible for the disposition of the estate must ensure everything proceeds in full accordance with the law of the taxing (or probate) jurisdiction.

For instance, if your estate is large enough to owe federal estate taxes, these taxes must be paid before property is transferred to the inheriting parties.

Nuts and Bolts of Paying Taxes on an Estate

For federal and state tax purposes, death triggers two events: it ends the decedent’s (person who died) last tax year for purposes of filing an income tax return, and it establishes a new, separate entity for tax purposes, i.e. the “estate.”

For federal tax purposes, it may be necessary to complete and file a Final Form 1040 federal income tax return, a Form 1041 federal fiduciary income tax return for the estate, Form 709 federal gift tax return(s), and/or Form 706 federal estate tax return. The specific requirement for any of these forms will depend on the decedent’s income, the size of the estate and the income of the estate.

Tax Responsibilities for Executors or Administrators

For state purposes, the “personal representative” (also called the “executor” or “administrator”) must file the appropriate state income tax return (assuming the decedent was required to do so while living) and any state income tax returns for the estate (if generating income) during the probate period.

The personal representative must also file all estate tax, inheritance tax (if any) and gift tax returns required by the state where the decedent lived. Note that in many states, gift, estate and inheritance taxes have been eliminated for most small- and medium-sized estates. The requirements for filing tax returns and paying taxes vary widely from state to state.

The personal representative needs to pay attention to other taxes in the probate process as well, such as local real estate and personal property taxes, business taxes and any special state taxes.

The personal representative should also be alert to the possibility that there may be unresolved tax issues for the tax years prior to the decedent’s death.

Getting Help

Being aware of these and other rules is critical to ensuring that the greatest amount of assets follow the will of the decedent, rather than the will of the IRS.

This is also part of why so many choose to hire estate planning lawyers to help guide them through the process. Even relatively small estates that don’t owe estate taxes or don’t have to go through probate can benefit from consulting with knowledgeable, licensed estate planning attorneys for the most important legal decisions.

Chris Jones is an attorney at Rogers, Sheffield & Campbell LLP, a Santa Barbara law firm. Click here to read previous columns. The opinions expressed are his own. This article is not intended to provide legal advice. For legal advice on any of the information in this post, click here for the form or phone number on the Rogers, Sheffield & Campbell Contact Us page.

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