Practical planning for the decedent's final return.

• Author: Lieberman, Alvin H.

The preparation of a decedent's final Federal income tax return requires consideration of a number of issues, such as whether and when to file a joint return, what types of income have to be reported, whether medical expenses are deductible, the treatment of gain or lose on property transactions, and the treatment of various carryovers. These and other thorny questions are addressed and illustrated in this article.

Every year, more than two million people residing in the U.S. die.(1) A decedent's business and personal affairs must be settled; a personal representative (PR) is selected to handle them. The PR is appointed by the appropriate court--an executor named in the decedent's will or an administrator (or other title) if the decedent died intestate (i.e., without a valid will) or without naming an executor. The PR takes charge of the decedent's probate property and winds up his affairs.

Among other matters, the PR is responsible under Sec. 6012(b)(1) for filing the decedent's Federal individual income tax return for the year of death ("final return"). Although the Pit's duties include filing all required tax returns due for the decedent (including the estate's Federal income tax return (Form 1041, U.S. Income Tax Return for Estates and Trusts), the Federal estate tax return (Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return) and the Federal gift tax return (Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return), this article addresses filing the decedent's final return.

There is surprisingly little guidance on the items to be reported on the decedent's final return. This article discusses the treatment of common types of income and deductions on the final return and various related procedures and elections.

The PR's Duties

Immediately after the decedent's death, the PR should apply for an employer identification number (KIN) for the estate by filing Form SS-4, Application for Employer Identification Number. The KIN is used on the estate income tax return (Form 1041) instead of the decedent's Social Security number(2); it should be given to payors of interest, dividends and other income that will be received by the estate, to be used on information returns (i.e., Forms 1099).

Under Sec. 6903, the IRS District Director should be advised of the decedent's death and of the Pit's identity. Although Regs. Sec. 301.6903-1(b) does not specify the method to be used, the easiest choice is Form 56, Notice Concerning Fiduciary Relationship, which should be filed with the IRS Service Center in which the decedent filed returns.(3) Under Regs. Sec. 1.6091-2(a), the final return is filed in the IRS district of the Pit's residence if the decedent filed single or married filing separately, or in the IRS district of the surviving spouse's residence if the decedent filed jointly.

The filing of Form 56 notifies the IRS to mail correspondence concerning the decedent's taxes to the PR and not to the decedent's last-known address. After filing Form 56, the PR assumes the rights and duties of the decedent with respect to Federal income taxes until advised such fiduciary capacity has been terminated. The fiduciary's liability for income taxes is usually in a representative, rather than a personal, capacity.(4) If such notice is not given to the IRS, Regs. Sec.301.6903-1 (c) provides that any deficiency letter mailed to the decedent's last-known address is sufficient notice; notice need not be sent to the PR.

According to Regs. Sec. 301.6903-1(b), when the Pit's fiduciary capacity has terminated, he should file with the IRS District Director with whom notice of appointment was filed written notice and evidence that such capacity has terminated (on Form 56).

The PR signs the final return and indicates his title (e.g., "Executor") next to the signature. The 1995 Instructions to Form 1040, page 35, state that the deceased taxpayer's name, "DECEASED" and the date of death should be written across the top of the return. Regs. Sec. 1.6072-1(b) indicates that the final return has the same due date as if the decedent had lived.

Example 1: B, a calendar-year taxpayer, died duly 20, 1996. B's 1996 (i.e., final) return is due (unless validly extended) by Apr. 15, 1997, as it would have been had B lived.

Example 2: F, a fiscal-year taxpayer with an October 31 year-end, died on July 20, 1996. If not extended, F's final return is due by Feb. 15, 1997.

Declaration of Estimated Taxes

Quarterly estimated tax payments need not be made by the PR on the decedent's behalf after death. Sec. 6654(e)(3)(A) permits a waiver of additions to tax for underpayment in unusual circumstances if the imposition would be against equity and good conscience; the taxpayer's death should be a circumstance that permits such a waiver. However, if the death occurs after the due date for an estimated tax payment, an addition to tax could be assessed for that period, under Sec. 6654(a).

Filing a Joint Return

The PR and the surviving spouse together determine whether a joint return should be filed for the year of the decedent's death. Regs. Sec. 1.6013-1(d) permits a joint return if the decedent was married at death, the surviving spouse did not remarry by the close of the tax year and both taxpayers have the same tax year. Regs. Sec. 1.6013-1 (d) states that a joint return may only be made by the PR; if the PR decides a joint return should be filed, the surviving spouse must agree. In making this decision, since Sec. 6013(d)(3) provides for joint and several liability on a joint return, the PR must consider the decedent's and the surviving spouse's tax situations and whether the estate should be exposed to such liability. Under Regs. Sec. 1.6013-1(d)(1), this joint return covers the entire tax year for the surviving spouse and the period ending with the date of death for the decedent. Items that affect the joint return decision, and tax planning suggestions, are discussed below.

If a joint return is filed, the decedent and the surviving spouse have a separate interest, rather than a joint interest, in any tax liability or refund.(5) The tax liability on a joint return is allocated to the decedent based on his relative separate tax liability.

Example 3: On a final return, H's (a decedent) and W's joint tax liability is $30,000. H's and W's separate tax liabilities (had they filed separately) would have been $24,000 and $12,000, respectively; thus H's share of the joint tax liability is $20,000 (($24,000 [divided by] $36,000) x $30,000).

The decedent's share of a refund from a joint return is the tax he paid in excess of his share of the joint tax liability.(6) If the parties file married filing separately, the estimated tax paid on the joint declaration (while the decedent was alive) must be apportioned between the decedent and surviving spouse. The IRS permits the surviving spouse and the PR to divide the estimated payments in any agreed proportion.(7)

The Instructions to Form 1310, Statement of Person Claiming Refund Due to a Deceased Taxpayer, provide that the form must be filed by anyone claiming a refund on behalf of a deceased taxpayer. There are special rules if the claimant is (1) the surviving spouse who fled the original joint return with the decedent or (2) the PR who fled an original return for the decedent.

Accounting Methods and Tax Year

Under Regs. Sec. 1.443-1(a)(2), an individual's tax year ends on his death. Income and deductions through the date of death are included on the final return using the...