Is an inherited estate required to file taxes?

March 28, 2022 by Jean Lee Scherkey, EA
1099 Form next to Calculator

I am the executor of my father's estate, who passed in 2020. We filed returns in 2021 for 2020. Now I receive 3 1099 forms - 1 for interest on his retirement account (less than 1K) and two from each of the two houses which were sold in the months after his passing. The value declared at death did not exceed proceeds. Is the estate required to file a return for 2021 (We had thought that since there was no income, no return would be required). Please advise.

Thank you,
Tom, Colorado



Dear Tom,

I'm sending you my sincerest condolences on the passing of your father. No matter what age we are, the passing of a parent is devastating, and the paperwork required to be completed can feel overwhelming, especially during times of grief. We are here to help, and we hope we can navigate you onto the right path so you can settle your father's estate with confidence.

You wrote your father passed away in 2020 and that you filed returns in 2021 for 2020. I am assuming the returns that you filed were your father's final Form 1040, U.S. Individual Income Tax Return, and any required state income tax returns. You indicated you recently received a Form 1099 showing interest under $1,000 from your father's retirement account and two Forms 1099 from the sale of two houses your father owned that were sold a few months after his passing. The value of the homes as of the date of your father's passing did not exceed the proceeds received on the home sales. Since there was no "net income," it did not seem like you needed to file a return to report the income.

The federal income tax return filing requirements are based on gross income, not net income. In other words, the filing requirement for the estate will be based on the selling prices of the homes, not the amount of gain realized from the sale. The filing thresholds for income generated from assets in a decedent's estate or trust are very low. For 2020 and 2021, a decedent's estate or trust is required to file a Form 1041, U.S. Income Tax Return for Estates and Trusts, when there is gross income of $600 or more. Although you do not mention the sales price for each of the sold homes, it is probably safe to assume your father's estate has met the filing requirement for 2021 based on the estate’s gross income.

Your father's estate plan will dictate who or what entity is required to report the income. Let's start with the income you describe as "interest from your father's retirement account." Sometime before your father passed, did he designate someone to inherit his retirement account upon his passing? Often, owners of retirement accounts, such as investment accounts, IRAs, 401ks, pensions, etc., will designate someone who will automatically inherit or receive the account when the owner passes. If your father had designated a person (known as a beneficiary), then it is possible the income may be reportable to the beneficiary and taxed on their return. If there is no beneficiary on record with the investment company or institution administering the retirement account, the income would be issued to the decedent's estate and reported on Form 1041.

Regarding the homes your father owned that were sold a few months after his passing: If your father's homes were in the name of his estate when they were sold, then the gross proceeds would be reported on Form 1041. Even though the gross proceeds are required to be reported, there may not be any tax assessed on the sale. Usually, when a person dies, the assets they owned at the date of death receive a new basis or valuation for federal tax purposes. The new valuation is the fair market value as of the date of passing. The new valuation is referred to as a "step-up" in basis because many assets, like homes, increase in value over time. Whether the property will receive a new valuation date for state tax purposes will depend on the probate rules of the state your father was a resident of and the state where the property was located, if different from where your father resided. You indicated the homes did not sell for more than their value as of the date of your father's passing. When you consider the deductible selling expenses, more than likely, each home has a net loss.

Although there is a filing requirement, whether there will be any tax due will depend on several factors. Just like individuals are allowed certain deductions against income, estates and trusts may also claim certain deductions against income. Examples of deductible expenses include administration fees such as trustee fees, legal and accounting expenses, tax preparation fees, state taxes paid, property taxes paid, appraisal fees, and probate court fees. When considering the possible net losses on the home sales and any allowable deductions, there may not be any tax due on the estate return.

Before a return can be prepared and filed, several administrative actions may need to occur. For instance, did your father have a trust? If he had a trust, were the homes and retirement account titled in the name of the trust when he passed? If your father had a trust and the assets were titled in the name of the trust, then the trust will dictate how the assets will be administered, who will receive any distributions, and when the distributions will take place. If either of the homes were transferred to a beneficiary before being sold, the sale would be reported on the beneficiary's individual income tax return.

If there was no trust and no direct beneficiaries listed on the assets, a probate might need to be opened. Where the probate estate is administered will depend on the state your father was a resident of when he passed. If the homes were in a different state from where your father was a resident, another probate might be required to be opened in the state where the property was located. To make matters even more complicated, if the estate administrator or any beneficiaries are residents of a state other than your father's, then those states may also require an estate return to be filed.

Due to the complex federal and state rules surrounding estates, it is often worth the time and money to consult with an estate attorney and tax professional that understands estate and trust taxation. Mistakes made on estates and trusts can quickly become expensive, and most estate administrators do not realize they can become financially responsible. If you have not already, I recommend contacting an attorney and tax professional specializing in estates and trusts and getting at least an initial consultation to understand the estate tax returns required to be filed and whether probate needs to be opened.

Wishing you a smooth process and many happy returns,
Jean

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Jean Lee Scherkey, EA
Learning Content Developer

 

Jean Lee Scherkey began her career at TaxAudit in 2015, and her current title is Learning Content Developer. She became an Enrolled Agent in 2005. For several years, Jean owned a successful tax practice that specialized in individual, California and trust taxation, and assisting those impacted by tax identity theft. With over fifteen years of varied experience in the field of taxation, Jean has worked at different private tax firms as a Staff Practitioner, Tax Analyst, and Researcher. Before coming to TaxAudit, she worked over two years for TurboTax as an “Ask the Tax Expert.” In addition to her work in TaxAudit’s Learning and Development Department, Jean is actively involved in the company’s ENGAGE Volunteer Program, which provides opportunities for employees to help and serve the local community.  


 

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