When an individual passes away, his/her will or trust identifies a representative to administer his/her estate. This representative is referred to as the executor (male) or executrix (female) and is generally approved or assigned by the local circuit court. The Internal Revenue Service tasks this representative to file a final personal return and information returns until the estate is completely transferred to the heirs. This article describes the use of the Form 1041 and how the representative does the accounting and prepares the tax return.
For the sake of ease, the article will only use the male pronoun for the deceased individual and the representative.
Whenever someone dies, he has yet to file his final personal tax return. It is the responsibility of the representative to gather the source documents for the Form 1040 and prepare the final return. In some cases, this representative has to file two years of final returns as it is not uncommon for the deceased to have not filed the prior year return. Naturally, the representative has to file not only the personal tax return from the prior year, but the return for the current year. The current year return will be a short year return. Anywhere from 1 calendar day to upwards of 365 days (if the deceased died on the last day of the calendar year) will have to have an accounting in order to file an accurate return.
The representative has to gather the source documents, which can include the following forms:
- Form 1099-Dividends, Interest, Capital Sales, or Sales (Form 1099-D,I, B, &S)
- Form K-1’s for any business interests
- Rental property information
- Information related to stock sales etc.
- Farming/Personal Business Information (Schedule C)
- Social Security Information
- Retirement Information (Form 1099-R)
- Government payments (Form 1099-G)
Once gathered, the representative has to divide the information between the two distinct accounting periods. The first are those days he was alive and those after he passed. Many banking, mortgage, brokerage, and retirement plan payment institutions do not know that the taxpayer has actually passed. These documents are important to separate the income between the two periods of time.
Once gathered, the representative should load the data into a spreadsheet and separate the income between the two periods of time. The latter period is the time after death often referred to as the ‘Trust Period’. Here, the information is documented and calculated for the ‘Trust’ period. This means, that after the day of death, all revenues and expenses associated with the deceased are in a trust entity. The representative files for an entity identification number via form SS-4, go to Resources Page and click on the SS-4 Form. Once a number is assigned, the period under ‘Trust’ is accounted for via Form 1041. Notice how the Form follows Form 1040. Form 1040 is for when you are alive; Form 1041 is for when you are dead.
Often the deceased is married. This complicates the situation somewhat as most married couples file a combined return. The representative only represents the deceased and does so in the deceased’s best interest. The representative may have to work with the spouse and sometimes may have to file a ‘Married Filing Separate’ tax return in order to protect the wishes and orders of the deceased. It is in the best interest of both the former spouse and the representative to communicate in order to pay the least amount of overall taxes to the government.
Once the final personal returns are complete, the representative will have to file a partial year Form 1041. It is rare for the deceased to die on the last calendar day of the tax year.
The Form 1041 is actually an information return. The deceased identifies one or more individuals as the heirs to the estate. The most common beneficiary is the spouse of the deceased. During the period of time where the estate is monitored by the court (often through a ‘Commissioner of Accounts’), the estate earns money via dividends, interest, and business income both passive and active. This income has to be reported to the IRS, in addition the corresponding deductions are accounted for in the estate and they too are reported to the IRS. The final amount of income is the net income that is reported to the IRS on behalf of the beneficiaries. The beneficiaries are those one to many individuals that will receive the assets of the deceased. While these individuals wait for transfer of the assets to their possession, these assets earn money. This income is pass-through to the beneficiaries and reported to them and the IRS via Form 1041 K-1. The K-1 is a reporting document similar to a W-2 or a Form 1099 identifying all income and the form of that income, corresponding deductions and credits to the beneficiary.
The Internal Revenue Service provides guidance on particulars via Publication 559, Survivors, Executors, and Administrators in how to report income and deductions.
Funeral and final medical expenses are not deductible in Form 1041. Medical expenses are a function of the deceased life and therefore deductible on the deceased’s final Form 1040 if allowed. The funeral expenses are a function of the deceased’s taxable estate and are included in the estate tax return, Form 706. See my article in the legal section and special taxation section as it relates to Form 706, the Estate Tax Return.
It is important for the representative to understand that there are 3 distinct forms of tax returns required upon the death of the taxpayer. Each is identified and described below:
Final Form 1040 – this is the final tax return of the taxpayer during the days he was alive.
Form 706 – This is the estate tax return, which identifies the entire wealth of the taxpayer at the moment of death. It basically identifies all assets and liabilities at that exact moment of death.
Form 1041 – from the moment he dies until the estate is completely distributed to the heirs, the assets earn money. These earnings are reported via the Form 1041 and assigned to the beneficiaries as if they had earned the money (Form 1041 K-1).
The Form 1041 is limited to the income earned and transactions that occur from the moment of death of the taxpayer until all assets are distributed to the heirs. The representative must be assigned and/or approved by the Circuit Court and this representative is responsible to ensure full compliance with not only the local law and state law, but the reporting requirements of the IRS. It is a duty not to be taken lightly. By understanding the above information as to the timing and the types of reports required, the representative can file the proper returns in a timely manner. The Form 1041 is used for Estate Tax Reporting and is also a tool used to report trust information (a future article). This article provided a basic understanding of the terms and timing of the respective reports. Act on Knowledge.