Income tax planning and elections for a deceased individual client.

• Author: Diss, William T.

The following planning points may be useful when reviewing income tax matters with the personal representative (executor) for a deceased client, and members of the family. In many cases, the discussion will be with the trustee of the living trust substitute for a will.

Final income tax return

* Estimated tax payments: Explain to the personal representative that installments due after the date of death need not be paid, except for the surviving spouse's taxable income (none, if there is no surviving spouse). The joint estimated tax should be recomputed to reflect only the surviving spouse's income (IRS Letter Ruling 9102010.)

* Medical expenses:

1. Medical expenses paid out of the decedent's estate during the one-year period following his death, as well as the expenses paid prior to death, can be deducted on the final income tax return (Sec. 213(c)(1)).

2. Generally, an estate tax deduction is preferable when the unlimited marital deduction is not used, because of the higher estate tax rate and the 7.5% of adjusted gross income (AGI) threshold for the income tax deduction.

   * U.S. savings bonds:

1. Consider a Sec. 454 election to report the accumulated redemption value gain as income on the final return, particularly if there will be a taxable estate, so that the income tax liability will be deductible on the estate tax return. (See IRS Letter Ruling (TAM) 9232006.)

2. This election does not bind the estate or beneficiaries on their returns (Rev. Rul. 58-435).

   * Passive loss activities: Consider a full estate tax valuation of the activity. The suspended Sec. 469 losses can be deducted to the extent of the excess of the estate tax value over the activity's adjusted basis (Sec. 469(g)(2)). The remainder of the suspended loss expires without tax benefit.

   * Annuity contracts: The unrecovered basis in an annuity contract is deductible on the final return. Any excess of the loss over other taxable income is treated as a net operating loss eligible for carryback deductions in prior years (Sec. 72(b)(3)(C)).

   * Principal residence sale: Consider a Sec. 121 election by the personal representative to exclude gain up to $125,000. Consent of the surviving spouse is required (Rev. Rul. 82-1).

   * Joint vs. married separate returns: Consider separate returns if the taxable income of each spouse reaches the top tax rate or if the surviving spouse perceives Sec. 6013 "difficulties." A computation should be made, comparing the tax liabilities under married filing separate status and joint status, after giving effect to the miscellaneous itemized deduction and medical expense thresholds and the 3% AGI itemized deductions disallowance.

   * Early distribution: Consider an early distribution by the estate to the surviving spouse in order to shift income into the final joint return (e.g., partnership income for the year of death reported on the fiduciary income tax returns) to use the decedent's expiring carryovers.

   * Joint income tax allocation:

   The personal representative and the surviving spouse can agree to an allocation of the income tax. The maximum deduction allowable on the estate tax computation is computed using the ratio of the decedent's tax under married filing separate status to the total taxes under married filing separate status multiplied by the actual joint return tax (Regs. Sec. 20.2053-6(f)).

   * Loan costs: The unamortized balance of any loan cost should be deducted in the final return.

   * Prompt assessment: Consider a request for prompt assessment of tax on the final income tax return; file Form 4810, Request for Prompt Assessment Under Internal Revenue Code Section...