In his book The Works of Benjamin Franklin, Benjamin Franklin wrote the following: “In this world, nothing can be said to be certain, except death and taxes.” Even back in 1817, Uncle Ben knew the long arm of the taxing system could stretch into the hereafter.
When a person dies, there is a potential of three different tax returns that may need to be filed.
Final Form 1040 U.S. Individual Income Tax Return
A final Form 1040 U.S. Individual Income Tax Return may be required to be filed if the deceased person earned enough income from January 1st until the day they passed to be required to file. For example, if an unmarried person under age 65 passes away in 2019, a final Form 1040 would be required to be filed if their income was $12,200 or more.
Form 706 United States Estate (and Generation-Skipping Transfer) Tax Return
When a person dies (known as the “decedent”), all of their assets (for instance their home, retirement accounts, investment accounts, household items, clothing, collectibles, etc.) are valued as of the day the person passed (or six months after called the “alternate valuation date”), and if the value of all the assets is more than the estate tax exclusion, IRS Form 706 United States Estate (and Generation-Skipping Transfer) Tax Return is required to be filed. The 2019 estate tax exemption amount is $11.4 million. In very general terms, this means that if a person dies in 2019, tax will be assessed on the value of their assets that are over $11.4 million. Of course, as with all things tax, this calculation is far more complex and would make walking five miles uphill in five feet of snow both ways to attend a tea party in Wonderland with the Mad Hatter seem like a much easier feat.
Form 1041 U.S. Income Tax Return for Estates and Trusts
Any income the decedent’s estate receives after the day of death until the end of the year is reported on Form 1041 U.S. Income Tax Return for Estates and Trusts. Examples of income include interest and dividends, wages earned, or retirement benefits paid after the decedent died, etc. The filing threshold for Form 1041 is much lower than an individual or estate return threshold. If the decedent received $600 or more in income between the day after death until the end of the year, Form 1041 is required to be filed. It is not uncommon for representatives of the decedent to have to file Form 1041 for a couple of years. Until the decedent’s assets are transferred to beneficiaries, any income earned on the assets will be reported on Form 1041.
Statute of Limitations
For all three of the above returns, the IRS generally has three years from the date the returns were filed to audit the returns. This time period is known as the “statute of limitations.” However, if the gross income reported on Form 1040 or Form 1041, and gross assets reported on Form 706, are understated by twenty-five percent or more, the IRS has up to six years to audit the return. The twenty-five percent understatement does not have to be deliberate for the IRS to extend the review period to six years. Also, if the returns are not filed, or if the IRS can prove a false or fraudulent return was filed in order to evade tax, the statute of limitations is considered to have never begun to run, which means it is unlimited until a return is filed.
For those of you who wish you had a time machine that made the three years go by faster, I have some good news. There is a way to cut the statute of limitations time from three years to eighteen months on the final Form 1040 and Form 1041. By submitting, in writing, to the IRS a request for a “prompt assessment,” the IRS will have eighteen months from the date the request was received by the IRS to assess any additional taxes on the returns. A prompt assessment can be submitted by filling out IRS Form 4810 Request for Prompt Assessment Under Internal Revenue Code Section 6501(d). However, if there was an omission of income totaling twenty-five percent or more or a fraudulent return was filed, the eighteen-month time limit will be voided, and the IRS may have as much as six years or more to audit the return. Keep in mind that a request for prompt assessment cannot be requested for Form 706.
A word of caution: Being the representative of a person’s estate is a huge responsibility. If, as the representative, you distribute all of the assets to the beneficiaries and the IRS later assesses additional tax, you and the beneficiaries can be held personally liable for the additional tax due. One of the ways to limit your personal liability as a representative is by submitting Form 5495 Request for Discharge from Personal Liability Under Internal Revenue Code Section 2204 or 6905 to the IRS. Generally, the representative of the estate will be discharged from personal liability nine months after the IRS receives the form for an Estate Form 706 return, and six months for the final 1040 and 1041 returns. Even though death and taxes may be a certainty, the tax part does not need to be a never-ending story. When the returns are filed properly, eventually the long arm of the IRS will recede, and the audit door will be closed.