The loss of a loved one brings a long list of emotional and practical responsibilities. Among those responsibilities are several tax-related matters that must be addressed for the person who has passed away and, in some cases, for their estate or heirs.
While every situation is different, there are several common tax issues families should be aware of after a death.
1. A Final Income Tax Return Still Needs to Be Filed
Even after someone passes away, their income for the year must still be reported. A final individual income tax return is filed for the year of death. This return includes income the individual received from January 1 through the date of death, such as:
- Wages
- Pension income
- Social Security benefits
- Retirement distributions
- Investment income
- Rental income
The responsibility for filing this return generally falls to the executor, personal representative, or surviving spouse. The return is filed in much the same way as prior-year returns, but some income may need to be split out and recorded as income for the estate or trust.
2. The Estate May Also Have Tax Filing Requirements
After a person passes away, their assets may continue generating income while the estate is being settled. When that happens, the estate becomes its own tax entity and may have filing requirements.
If the estate earns more than $600 in gross income after the date of death, it generally must file an estate income tax return using IRS Form 1041. The estate typically obtains its own Employer Identification Number (EIN) for this purpose. Financial Power-of-Attorney documents expire upon death. These actions are the responsibility of the executor of the estate, which, is sometimes the same person.
In addition, larger estates may be required to file a federal estate tax return using IRS Form 706. Most families will not owe federal estate tax because the exemption amount is very high. However, in some situations an estate tax return is still filed to preserve the portability election, which allows a surviving spouse to use a deceased spouse’s unused estate tax exemption.
Depending on where the person lived, there may also be state estate or inheritance tax considerations.
3. Trusts May Have Their Own Tax Responsibilities
If the decedent had a living trust (often called a revocable trust) or their will creates a testamentary trust, additional tax filings may be required.
Revocable living trusts become irrevocable at death. When that happens, the trustee may need to obtain its own Employer Identification Number (EIN) and file annual income tax returns using IRS Form 1041.
Similarly, if the will establishes a testamentary trust for beneficiaries—such as minor children or heirs receiving assets over time—that trust may also need to file its own tax return each year while it holds assets.
Trust taxation can be complex because income may either be taxed to the trust or passed through and taxed to the beneficiaries. Proper administration and tax reporting are important to avoid penalties and ensure the trust operates as intended.
4. Beneficiaries Often Receive a “Step-Up” in Basis
One of the most important tax rules affecting inherited assets is the step-up in basis. When someone inherits assets such as stocks, mutual funds, or real estate, the tax basis is generally adjusted to the fair market value on the date of death.
For example:
- If your parent bought stock for $10,000
- And the stock was worth $50,000 at the time of their death
- Your new tax basis is generally $50,000, not $10,000
This rule can significantly reduce the capital gains tax when the asset is later sold.
5. Retirement Accounts Are Treated Differently
Assets in retirement accounts—such as Traditional IRAs, Roth IRAs, and employer plans—do not receive a step-up in basis. Instead, beneficiaries generally must withdraw the funds according to inherited account rules. Under current law from the SECURE Act, many non-spouse beneficiaries must withdraw the full account balance within 10 years.
Because these withdrawals can create taxable income, planning the timing of distributions is often important.
6. Organization Early On Can Prevent Problems Later
In the months following a death, families often receive a wide range of tax documents including:
- Final W-2s
- 1099s for investment income
- Retirement account statements
- Brokerage records
- Property information
Keeping these documents organized and sharing them with your tax professional early helps ensure that all filing requirements are met and opportunities for tax savings are not missed. Obtaining required estate or trust EINs and assigning them to the assets must also be done as soon as possible to assist with separating income and assets.
How Our Firm Can Help
The tax responsibilities following a death can be complicated, particularly when estates, trusts, or inherited assets are involved. Our team regularly assists clients with:
- Preparing final individual tax returns
- Filing estate and trust income tax returns
- Advising beneficiaries on inherited assets
- Coordinating with estate attorneys and financial advisors
- Planning the tax impact of inherited retirement accounts
If your family is navigating the loss of a loved one and you are unsure what needs to be done from a tax perspective, please reach out to our office. We are here to help guide you through the process and ensure everything is handled properly.