Contributed by: PhillipB, FreeTaxUSA Agent, Tax Pro
When a loved one passes away, there’s a lot to handle, including figuring out which tax returns need to be filed. FreeTaxUSA only handles Form 1040, which includes the final return of a decedent and any individual tax returns for beneficiaries, but it’s important to understand the other filing requirements that may exist. Here are the three main tax returns that may need to be filed:
💡NOTE: FreeTaxUSA only has support for Form 1040. If any of these other returns are needed, you may need to find a local tax professional to file those returns.
What income is reported on a decedent’s final return?
Income reported on a decedent’s final return depends on the decedent’s type of tax year and accounting method. Most individuals will be calendar year, cash basis taxpayers, but it’s possible to elect to be a fiscal year taxpayer and/or to use an accrual method for individual income tax returns – so, we’ll discuss both.
Cash basis, calendar year taxpayers report all income that is constructively received after January 1 and before the date of death. Cash basis means the income is available for the decedent to use—like cash in hand—up until the death date. Therefore, only income that was received and available for use before the date of death is reported on the final return.
For example, George was a cash basis, calendar year taxpayer. He passed away on June 1. Before his death, he completed the sale and delivery of cattle, with the payment check arriving on May 31. Since the check was received before his death, it counts as income on his final tax return, which covers January 1 through June 1. The calendar year would be a 5-month short year return from January 1 to June 1.
Accrual basis, fiscal year taxpayers will report all income that was normally accrued before the date of death. Income is considered to have normally accrued when all events have occurred that secure a taxpayer’s right to the income, and the income amount can be accurately determined.
Returning to the prior example, with the exception that George is now an accrual basis taxpayer. If he delivered the cattle to the buyer before his date of death and the buyer hadn’t sent payment until after his death, the income would be accrued income, since George had satisfied all the requirements for earning the income.
Assuming the amount of payment is also known, this income is reported on his final return even though the money had not been sent to him by his date of death.
If George was a fiscal year taxpayer with a tax year starting at the beginning of August to the end of July the following year, his final return would report income received from August 1 (of the previous year) to June 1 ((George’s date of death and before July 31) – an 11-month short year return.
For a detailed explanation of each item of income and deductions that should be included in a decedent’s final return, see this section of IRS Publication 559.
What is income in respect of the decedent?
Income in respect of the decedent is simply the income that would have been reported on the decedent’s final return if the income had been received or accrued before the date of death, but it arrived after the date of death. This income isn’t reported on the final Form 1040 individual tax return, rather it’s reported by the estate, beneficiary, or person who has the right to receive the income.
Going back to George’s cattle sale example with cash basis, calendar year reporting, if payment was not received until June 2, the income isn’t considered constructively received. Since it arrived after his date of death, it’s become income in respect of the decedent and isn’t reported on his final tax return. The only exception is if he was married at the time of death, his spouse is the beneficiary of the estate, and she chooses to file jointly for the final tax return with him. The income would appear on his final joint tax return as her income.
If George was single and didn’t have a beneficiary or person who has the right to receive the income with an unsettled estate, the income in respect of a decedent is reported as estate income on Form 1041 with a tax year that starts on the date of George’s death and ends at the end of the calendar year.
Income in respect of a decedent will never be reported on the decedent’s final return unless the income has become the income of the surviving spouse, and the surviving spouse files the final return jointly.
How is income in respect of the decedent reported?
How this income is reported depends on whether the income is rightfully inherited by an individual or if the income is still part of the estate.
Income from an unsettled estate is reported on Form 1041. If it’s distributed, it passes through to beneficiaries—like a partnership or S-corp and the beneficiaries are responsible for any applicable income tax. If not, the estate pays the tax.
The will or trust documents dictate when income is distributed. For example, a trust may hold income for heirs over their lifetimes, or an estate may simply distribute income once the court settles inheritances. The estate is required to file its own return for as long as it receives and holds income.
If the income in respect of a decedent is taxable on an individual’s return, the income should generally be taxed the same as it would have been had the income been reported on the decedent’s return. This is true even though the income may be reported on Forms W-2 and 1099 differently than when the decedent was alive.
For example, a decedent’s W-2 income for the portion of the year paid after the date of death, will have the federal taxable wages normally included in box 1 reported directly to the beneficiary on Form 1099-MISC in box 3 as other income. The social security and Medicare taxes withheld will still be included on the W-2, but the Federal wages reported on Form 1099-MISC will be excluded from box 1, Federal wages.
IRS Publication 559 has a great explanation of the types of income in respect of a decedent and how deductions in respect of the decedent are treated. Here’s a cursory breakdown, but go to Publication 559 for greater detail:
- Wages: As mentioned above, wages will be reported on a 1099-MISC. This would be reported as other income on a 1040 in Schedule 1.
- Farm rents: A cash basis farmer who receives rent in the form of crop shares or livestock and owns the crop shares and livestock at the time of death, has income in respect of decedent when the crop shares and livestock are sold. Same is true for crop shares and livestock that the decedent has a right to at the time of death.
- Partnership income: Payments or distributions that are liquidating a decedent’s interest in a partnership are income in respect of the decedent after death.
- Deductions: Business expenses, income-producing expenses, interest, and tax liabilities of the decedent that aren’t deductible on the decedent’s final return are deductible on either the estate or the beneficiaries’ return when they are paid.
Key takeaways
Losing a loved one comes with many challenges, including sorting out taxes. Understanding the income received—the source, when, and who it belongs to—helps determine what should be reported on the decedent’s final return, the beneficiaries’ returns, or the estate’s tax return. Once you have all the income details and know what gets reported on the decedent’s final return, you can move forward with filing your loved one’s final return.