This is my eighth post on my continuing series on the Virginia Probate Administration taxes. You can read previous posts on this series including Part I: introduction to probate (here), Part II: qualifying to be the personal representative (here), Part III: the duties and liabilities of the personal representative (here), Part IV: the initial steps (here), Part V: inventory and accountings (here), Part VI: Exemptions and Creditors (here), and Part VII: Augmented Estate and Exemptions (here).
While probate administration is complex with numerous issues and responsibilities, the most pressing concern I hear from clients are deal with taxes the estate may have to pay. Clients are rightfully concerned taxes will wipe out the assets in the estate. They tend to overlook the multifaceted impact tax issues place on a personal representative and an estate. Not only could the estate owe estate taxes (either state or federal) but the estate could also owe unpaid income tax derived from income earned by the decedent prior to the decedent’s death or on income earned on estate income after the death of the decedent e.g. the estate receiving a dividend payment from a mutual fund.
Estate Income Tax
Many people are just plain unaware that an estate could owe state and federal income taxes. Under Virginia law, the personal representative must file an estate income return under the same requirements for that of a living person’s return – April 3oth for Virginia returns and April 15th for the federal returns.
To start the process, an estate is consider a separate tax entity from the decedent and, thus, the personal representative must apply for a separate tax identification number, or Employee Identification Number, “EIN”(similar to a Social Security Number for an individual) to file the estate’s income tax returns. You can acquire an EIN here to begin the process of filing an estate income tax return. The generated EIN must be used on all tax filings instead of the decedent’s social security number.
The personal representative also has a duty to file any prior income tax returns that were not filed by the decedent for earlier years. In other words, if the decedent died in January 2009 and did not file any tax returns for 2008, for whatever reason, the personal representative would have to file returns for 2008 and 2009. If older tax returns had not been filed and a refund is owed; the personal representative would generally need to file a return for the refund in their fiduciary role to protect the estate’s assets. The personal representative must file a 1041 income tax return (similar to an individual’s federal schedule 1040) in any year the decedent had a gross income in excess of $600. The personal representative must also issue a Schedule K-1 (like a 1099) to each beneficiary. If ancillary probate administration is needed additional tax filings would be owed in those states where ancillary probate is opened.
The IRS takes the view, not surprisingly, that federal income tax returns are owed prior to the payment of any creditors. As part of their fiduciary duty, a personal representative would be personally liable for any taxes owed if the personal representative was on notice of the tax deficiency and distributed estate assets to beneficiaries. Although there are some differences, the income tax liability for an estate is figured in much the same way as it is for an individual’s income. Also, if a Federal fiduciary income tax return is due then a Virginia Fiduciary Income Tax return must also be filed on Form 770.
In 2010, there is no federal estate tax applicable. And determining what the 2011 estate tax system will look like is similar to finding a needle in a haystack. However, there are still concerns for a personal representative.
First, for decedent’s dying in 2010, the personal representative needs to be aware that under the Economic Growth and Tax Relief Reconciliation Act of 2001 (“EGTRRA”), Congress greatly restricted the ability to use stepped-up basis for capital gains a beneficiary would acquire when assets are transferred at death. The removal of stepped-up basis was implemented to pay for the 1 year sunset on the federal estate tax in 2010. But, there are a number of exceptions and you can learn more on the removal of stepped-up basis here.
Second, what estate tax law is applied to the decedent’s estate is governed by the date of death of the decedent. If the decedent died in a year other than 2010, different tax laws would be applicable and the estate could owe federal or state estate taxes. For instance, in 2006 the Virginia General Assembly repealed the Virginia estate tax for the estates of decedents whose date of death occurred on or after July 1, 2007. However, the Virginia estate tax provisions remain in place for decedents dying prior to July 1, 2007.
It has been a long journey on the Virginia probate process but I think I can wrap it up next time. I hope…