The federal estate income tax return is a difficult tax return for an executor to file. The different income types and complex deductions involved in the return causes confusion for the executor.  Therefore, most executors will hire a tax professional skilled in estate tax returns to help them prepare and file the federal estate income tax return.

Establishing a Due Date for the Federal Estate Income Tax Return

Initially, the tax professional and executor need to select an accounting period to file the federal estate income tax return. Similar to the individual returns, the IRS allows for two accounting periods for the federal estate income tax return: calendar year or fiscal year.

The discussion to select the proper accounting period should happen early in the estate administration. Essentially, selecting an accounting period will establish a due date for the return and a guideline for the executor. The executor can use the guideline to build an effective administration plan that will limit the taxable estate income. In addition, the executor may limit the number of estate income tax returns to file. For instance, if the estate is still earning income by the due date, the executor must file a second estate income tax return; both federal and state (if a state requires a state estate income tax return).

Typically, the tax professional will select the accounting period that will allow the most time to close the estate. This will help in limiting the tax liability and avoid filing multiple estate income tax returns.

Preparing the Federal Estate Income Tax Return

The actual preparation for the federal estate income tax return happens while administering the estate. While the executor is closing assets, the executor is also tracking the estate income and estate expenses. This information will be vital to the tax professional when it’s time to complete the return.

In addition to tracking income and expenses, the executor may need to complete an early distribution. In a well-funded estate with excessive estate income, the tax professional may try to use the income distribution deduction. Therefore, the tax professional may ask the executor to complete an early distribution.

Basically, the tax professional will always try to cut the tax liability of the estate. So, preparing the federal estate income tax return is where all the income and expense tracking will pay off.

Deciding on Who Pays the Estate Income Tax

The IRS allows for the payment of the estate income tax in two ways:

1. Pass the taxable income to beneficiaries through the use of Schedule K-1(Form 1041).
   
2. The estate will pay the estate income tax from estate funds.

Basically, the decision comes down to the amount of taxable estate income. If the estate income is excessive, the tax professional will opt to pass the taxable estate income to the beneficiaries. Since the tax rates are lower for individuals than estates, the tax liability for the estate will be lower and the beneficiaries will receive more of the assets than the IRS. Conversely, if the estate income is minimal, it’s easier if the estate pays the tax bill.

The Executor Role in Filing the Federal Estate Income Tax Return

In the end, after the tax professional completes the returns, the executor must check for accuracy. If the information on the return is accurate, the executor then signs the returns. That’s the only role the executor plays in filing the federal estate income tax return. The work is in preparing the return where the executor must take a much more active role. If the executor listens to the tax professional, accurately tracks the estate income, and accurately tracks the expenses of the estate, preparing the federal estate income tax return becomes less difficult.

A Note about Preparing the State Estate Income Tax Returns

Along with the federal estate income tax return, some states require a state estate income tax return. To avoid repetition, the tax professional will use the same information used for the federal estate income tax return. However, in a state like Massachusetts, the two returns have differences. So, the tax professional will provide guidance to the executor if there is a need for new information. Since the tax professional already possesses all the information the executor can provide, the request for additional information is unlikely. Therefore, the tax professional usually handles the differences leaving the executor with no worries concerning the state return.

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Recommended Reading

Tax Returns and the Date of Death – This article will give you the requirements and due dates for the Estate Income Tax Returns.

Estate Income Tax Rates and your Estate Plan – The article explains tax rates for an individual as compared to an estate and the effect on your estate.

Track the Administration Expenses of the Estate – The article describes administration expenses used to offset estate income.