Serving as the executor or administrator of an estate or successor trustee of a trust is often viewed as a position of prestige. It should instead be considered a position of responsibility and potential liability. If you agree serve in this role, you will have obligations to the beneficiaries, creditors of the estate, and the clerk of court. It is easy to focus on the immense task of collection, inventory, and division of assets. But when you say “yes” to being someone’s personal representative, you are also personally guaranteeing the IRS that all of the decedent’s taxes will be paid properly.
For simplicity, I will use the term “personal representative” to refer to executors, administrators, trustees, and anyone else that is required to file, and the word “estate” to refer to both probate estates and administrative trusts.
Who is Responsible for Filing?
The IRS will look to anyone who is in charge of the decedent’s property for taxes due. That is usually an executor, administrator, or the successor trustee of a revocable trust. But if no such fiduciary is appointed, anyone who is in actual or constructive possession of any property of the decedent is responsible for tax returns. This includes the decedent’s agents and representatives, safe-deposit companies, brokers holding securities of the decedent as collateral, and the decedent’s debtors. If you receive property from the decedent in any capacity, you should make sure his or her taxes are paid.
Notice of Fiduciary Relationship
If you serve as personal representative, you should file a Form 56, Notice Concerning Fiduciary Relationship, as soon as you have all of the necessary information. This notifies the IRS that you are assuming the powers, rights, duties, and privileges of the decedent and makes sure that the IRS sends tax information to you, and not the decedent’s last known address. You don’t want to be sued for failing to pay the decedent’s back taxes because notices went to the wrong address. The notice remains in effect until the personal representative notifies the IRS that the fiduciary relationship with the estate has terminated.
Under 26 U.S.C. § 6901(a) and 31 U.S.C. § 3713(b), a personal representative is personally liable for a decedent’s unpaid income and gift taxes if he or she knew the debt existed and distributed the estate without first paying the taxes. There are some debts that can be paid before the IRS. But if the personal representative improperly distributes estate assets that should have been used to pay taxes, he or she is personally liable to the extent of the improper distribution. Knowledge of the tax debt includes notice of facts as would “put a reasonably prudent person on inquiry as to the existence of the unpaid claim of the United States.”
If you do not have the decedent’s prior tax returns, you can request these by sending Form 4506-T to the IRS. This will confirm whether the decedent filed returns and demonstrates your good faith in determining the extent of the tax liability.
26 U.S.C. § 6501(d) permits personal representatives to request a prompt assessment of income and gift taxes, including penalties, owed by the decedent. This is accomplished by the filing of a Form 4810. The request shortens the statute of limitations on future assessments from three years to eighteen months, except in cases where no return was filed, the return filed was false or fraudulent, or the return failed to report 25% of the gross income or gifts.
When Form 4810 requests are received, they are associated with the applicable tax returns and are reviewed for audit or acceptance as filed. If accepted, you will receive a letter advising that the returns have been accepted. However, if the return is not accepted, it is selected for audit and sent to the appropriate District Office. Therefore, filing a Form 4810 may speed up the process and shorten the statute of limitations. But it may also result in an audit.
Decedent’s Final Income Tax Return
The personal representative is required to file income tax returns for the decedent if a return is due. The decedent’s Form 1040 and state income tax return for the year of death, and for any preceding years for which a return was not filed, are required if his or her income for those years was above the filing requirement. The requirements are different for different circumstances.
Estate Tax Return
In some cases, a personal representative will also file a Form 706 federal estate tax return. This is only required for estates valued at the exemption amount of the year of death. For 2019, that number is $11.4 million. So there aren’t too many cases where a Form 706 must be filed. But there are times when it may be a good idea.
Since 2010, the surviving spouse of a decent has had the option of picking up the deceased spouse’s unused exemption and adding it to the surviving spouse’s own exemption. This was more important before the 2018 Tax Cuts and Jobs Act, which doubled the exemption amount. But for larger estates, this may still be necessary. The current tax rules are temporary and the exemption may go down. If there is any possibility that the surviving spouse’s gross estate may be taxable, portability should be considered.
The personal representative or trustee may also wish to file an estate tax return for the purpose of making a qualified terminable interest property (“QTIP”) election. There are several cases in which you may choose to create a QTIP trust in your estate plan. QTIP trusts give the surviving spouse asset protection, allow the deceased spouse to provide income to the survivor and control what happens to property upon the survivor’s death, and allow the property held in trust to be counted in the surviving spouse’s estate. This allows a second basis adjustment when the second spouse dies. When making a QTIP election on a Form 706, it usually makes sense to elect portability as well.
North Carolina abolished its inheritance tax in 2013. However, there are several states that still have estate or inheritance taxes.
Discharge from Liability
After you file the decedent’s final income tax returns, you may apply to be released from personal liability for the decedent’s income, gift, and estate tax pursuant to 26 U.S.C. §§ 2204(a) and 6905(a). You may apply for discharge from all three taxes by completing Form 5495. The IRS has nine months from receiving an application to inform you if any tax is due. If you pay the tax, or if the IRS fails to respond within nine months, you are discharged from personal liability. Even if the request is granted, the IRS can still assess deficiencies against the estate or its beneficiaries, heirs, and transferees.
Estate’s Income Tax Return
A personal representative may also be required to file income tax returns for the estate. These are filed on a Form 1041. For 2018, estates were required to file income tax returns if they had gross income of $600.00 or more.
When an income tax return is required, it is important for the personal representative to determine the most tax efficient way to make distributions. If a distribution of earnings is paid to a beneficiary, the estate does not owe tax on that distribution. Instead, the income is passed through to the beneficiary, who report the distribution as income on his or her personal tax return. The estate issues a Schedule K-1 to the beneficiary to use in preparing his or her return. This can be important because the estate may have a much higher tax bracket than the individual beneficiary.
For calendar-year estates, the return and any tax owed is due by April 15, just like an individual’s tax return. Fiscal-year estates must file by the 15th day of the fourth month after the fiscal year ends. The IRS will assess penalties for late returns and late payments but will also grant an extension if requested.
Notice of Termination of Fiduciary Relationship
You can let the IRS know that you have completed your duties as personal representative by filing a second Form 56.
This is meant only as a summary and overview. There are many other tax and non-tax issues that arise in the administration of an estate. We always suggest that our clients hire an accountant to guide them through the process of filing fiduciary returns.