It goes without saying that the death of one's spouse is typically an extremely difficult emotional trauma. When one loses a spouse, the last thing on the surviving spouse’s mind is the tax issues to be addressed.
Nonetheless, the passing of one’s spouse will likely lead to certain federal income tax tasks and responsibilities. Among other things, you'll need to learn the proper procedure for filing and signing your spouse's final income tax return, and you'll need to review the applicable filing status rules. Certain other tax issues may also come into play, which will also be discussed.
Specific procedures must be followed if you are filing and signing your spouse's final income tax return.
- When you file a return for the decedent as the surviving spouse, the return must be completed according to some specific rules. You must write "DECEASED" across the top of the tax return, along with the decedent's name and date of death.
- If a joint return is filed, the surviving spouse must also sign the return. If no personal representative has been appointed by the due date for filing the return, the surviving spouse (on a joint return) should sign the return and write "Filing as Surviving Spouse," in the signature area.
There are many other rules that come into play when filing a final return for a deceased spouse.
Be aware that the date of death determines the amount of income and deductions that will be reported on the tax return.
- In general, marital status is determined on the last day of the tax year (December 31). However, special rules apply when a married taxpayer dies; married filing jointly status is usually allowed for that tax year, even if the death occurred on January 1.
- If the decedent was married, however, it is important for you to calculate whether the tax on a joint return would be less than the total tax owed on two separate returns. Keep in mind that, although a joint return will include all of the income and deductions of the survivor for the entire year, it will only include only the income and deductions of your deceased spouse up until the date of death.
If certain property was not owned jointly with the surviving spouse but passed to the decedent's estate at death, the subsequent income on that property would be reported on the income tax return for the estate (Form 1041), not on the joint income tax return. For example, if the deceased spouse owned a bank account, interest income earned through the date of death would be included on Form 1040. However, interest earned after death would be reported on Form 1041.
For the surviving spouse, one of several filing statuses may be appropriate. These can range from married filing jointly, to married filing separately, to qualifying widow(er), to head of household.
- In the year of a spouse's death, the surviving spouse usually is considered married for the entire year, for tax purposes. Therefore, the surviving spouse can file a joint return for that year. This rule also applies if both spouses die during the same tax year.
- A joint return can be made only with the cooperation of the executor or administrator of the decedent's estate. However, the surviving spouse can file a joint return with the deceased spouse, assuming the decedent had not filed a tax return (as married filing separately) for his or her year of death, before death. Also, no executor or administrator could have been appointed at or before the filing of the joint return or before the due date for filing the return of the surviving spouse, including extension.
“In general, a surviving spouse should calculate taxes both according to the married filing jointly status and the married filing separately status, to determine the most advantageous approach. If the surviving spouse remarries before the end of the year, the married filing separate status must be used for the decedent's final return.” –Gary Sigman, CPA
Although a joint return cannot be filed with the deceased spouse for a tax year after the year of death, the surviving spouse can use the married filing jointly tax rates and standard deduction amount by filing as a "qualified widow(er)" in each of the following two years. To qualify, the surviving spouse must be unmarried and pay more than half the cost of maintaining the principal home for the entire year of a child who qualifies for a dependency exemption on the surviving spouse's return.
- If you are not eligible to file jointly or as a qualified surviving spouse, head of household filing status is the best alternative to minimize tax (assuming that you qualify). This is because the tax rates are lower and the standard deduction higher than if you file single or married filing separately. It's possible that you may qualify for head of the household status if you provide support for a grandchild, sibling, or another relative, and meet all applicable conditions.
- Married filing jointly in the year of a spouse's death can have both advantages and disadvantages. For example, if the deceased spouse has capital losses and the surviving spouse has capital gains, these amounts may be combined on a joint return. This is important since if an individual passes away with an unused capital loss carryover, it expires unused.
It's important to note that if a capital loss carryover has been generated on a joint return, it must be determined which individual(s) generated the capital loss. Once this is determined (by reviewing prior tax returns and related records of securities sales), the entire capital loss carryover must be reduced by the decedent's portion of the carryover.
A potential disadvantage of filing a joint return might be when a higher adjusted gross income results from combining income, thereby disallowing certain itemized deductions, due to certain limitations (i.e., miscellaneous itemized deductions must exceed 2% of adjusted gross income to be deductible).
- There is also a potential advantage when a surviving spouse sells a principal residence within two years of the spouse's death. In this case, the larger $500,000 gain exclusion (which is normally only available for joint filers) is still available, as opposed to the smaller $250,000 exclusion for unmarried taxpayers.
If the gain on the sale of the residence is less than $250,000, this rule won't be beneficial, which, in many instances, will be the case, due to the step up in basis rules.
- Another important consideration occurs when a spouse inherits property from a deceased spouse. Assume that a mutual fund was owned jointly at the death of the spouse. The surviving spouse obtains a step-up in basis on one-half of the asset.
For example, Capital Asset Fund was purchased for $10,000 and titled jointly. Assume there were no reinvestments of dividends or capital gains, and the alternate valuation date of six months after death was not utilized.
At the first spouse's passing, this fund was worth $20,000. The new basis to the surviving spouse is now $15,000 (one-half of the original basis plus one-half of the value at death). Please note that base issues for residents of community property states may be treated differently than in the above example.
- If a surviving spouse inherits an IRA or retirement plan account from a deceased spouse, more favorable RMD (Required Minimum Distribution) rules apply if the survivor is younger than the deceased.
The surviving spouse can elect to treat the inherited account as their account, and may delay taking the RMD until age 70 1/2 if they so choose. This election may not only defer tax but may reduce tax, especially if the surviving spouse is in a lower tax bracket, down the road.
As you can see, there are many important tax issues that need to be addressed when a spouse dies. If you have any questions, please contact me at firstname.lastname@example.org or any one of the tax professionals at Zinner & Co. We’re ready to start the conversation.