An often overlooked aspect of estate planning is taxes. After all, death does not extinguish any tax debt that you may owe to the Internal Revenue Service or the State of California. It is possible your estate will owe tax for income earned on your assets even after your death.
Federal Government Collects on Unpaid Estate Tax Bill
For example, the estate of some wealthy Californians may be liable for the federal estate tax. The estate tax is technically a “tax on your right to transfer property at your death.” But most estates will never owe this tax because the law contains a sizable exemption before tax is assessed. For individuals who die in 2016, the exemption is $5.45 million. There is also an unlimited “marital deduction” for transfers from a deceased spouse to a surviving spouse.
The estate tax cannot be avoided by transferring your assets to a revocable living trust. A recent federal case from here in California illustrates this point. In this case, the federal government sued the estate, co-executors, and heirs of a California man who died in 2004. The decedent left a “pour-over” will directing his executors to transfer any probate assets from his estate to a revocable living trust that he had established some years before his death. Although the trust directed the trustees to pay any estate taxes due, no payment was apparently made, even after negotiating several extensions with the Internal Revenue Service. Eventually, the IRS declared the estate in default and sued to enforce the tax debt. None of the defendants appeared before the court, and a federal magistrate recommended the court grant a default judgment for the government against all defendants, who are each individually liable for the full amount of the taxes due.
Dealing With Tax Issues in Your Estate Plan
Even if you do not expect to leave a large enough estate to worry about the federal estate tax, there are other tax issues you should still consider when making your estate plan. For one thing, your personal representative will likely have to file a final Form 1040 and state income tax return on your behalf. These returns must cover any income earned up to the date of your death. For any income earned after death—interest on a bank account, stock dividends, business receivables, et al.—your personal representative must file a separate “fiduciary return” on behalf of the estate.
Your estate may also be responsible for paying any tax debts owed at the date of your death. Such debts take priority over any distribution of property specified in your will or trust. Conversely, your estate may also be in a position to collect any federal or state tax refunds pending. This is why it is important to make a will and name a personal representative who can ensure your tax (and other) affairs are properly managed. If you would like help from an experienced San Diego estate planning lawyer, contact the Law Office of Scott C. Soady today.