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Filing the Estate Income Tax ReturnFiling the estate income tax return is a complex undertaking for the common executor. Fortunately, at the federal level, the executor must file the estate income tax return only if the earned income after death reaches $600.00 or more. So, with proper planning, you could minimize the income earned by the estate after death and possibly avoid the estate income tax entirely.

Ways to Minimize the Earned Income after Death

According to the article Track the Estate Income, the four common types of income that keep earning after death are the following:

  1. Interest Income
  2. Dividend Income
  3. Rental Income
  4. Capital Gains

To reduce the income earned after death, it is imperative to identify the assets in your estate that will earn income and plan accordingly. The following tips are ways you could reduce or eliminate any income from your estate after death:

  • List beneficiaries to your retirement accounts. You must list beneficiaries to your 401(k), IRA, etc., because failing to do so will produce income for the estate when the executor closes these accounts. As a result, the amount will exceed the $600.00 threshold forcing the executor into filing the estate income tax return. By listing beneficiaries to retirement accounts, the accounts become property of the beneficiaries, not the estate.
  • Own rental property in joint tenancy. In simple terms, when one owner dies, ownership of the property goes to the surviving joint tenant. So, any rental income in this situation is not the income of the estate. However, joint tenancy isn’t so simple. There are many forms of joint tenancy regulated by state law. As a result, circumstances can force the property into formal probate such as both joint tenants dying at the same time. To avoid the uncertainty of joint tenancy and state regulations, a living trust for your real property may be a better option. Refer to the book Plan Your Estate by Nolo for a more in-depth look into this topic.
  • Set up your bank accounts as Payable on Death Accounts (POD). Like retirement accounts, POD accounts let you list beneficiaries to your bank accounts. Upon your death, the accounts become property of the beneficiaries making any income earned taxable to the beneficiary. This sounds nice in theory, but some states won’t allow POD accounts. Contact your bank and ask about POD accounts.
  • Set up your brokerage accounts as Transfer on Death Accounts (TOD). Like POD accounts, TOD accounts allow you to add beneficiaries to your accounts. All property in the TOD accounts will transfer to your beneficiaries after death making any income earned after death taxable to the beneficiaries. Again, some states don’t allow TOD accounts. So, contact your broker and ask about TOD accounts. Also, in some states you can apply a TOD registration to cars and other assets such as your home. So, you can do a lot with TOD registrations, if allowed in your state.
  • Give your taxable assets away while you are still alive. You and your spouse may gift up to $14,000.00 each before you must file a gift tax return in a given year. So, you and your spouse can give each prospective beneficiary $28,000.00 annually without any tax consequences. This tactic will certainly reduce taxable income to your estate after death.

States and the Estate Income Tax

In some states, estate income tax rules apply as well. For instance, Massachusetts has to file a Massachusetts estate income tax return(Form 2) if the estate earns $100.00 or more after death. So, state law plays a role in estate income taxes. As a result, it may not be possible to avoid the estate income tax entirely.

Note: Not all states need to file an estate income tax return. So, check with your state taxing authority for requirements concerning the estate income tax, if any.

Filing the Estate Income Tax return

Having to file an estate income tax return is not a catastrophe. In the federal estate income tax return(Form 1041), the executor can opt to pass the income to the beneficiaries through Sch-K1. The same option applies to the Massachusetts estate income tax return(Form 2), which passes income to the beneficiaries using Schedule 2K-1. These options allow the estate to avoid the compact estate tax rates by taxing the income at the personal rates of the beneficiaries;thus, lowering the tax.

Conclusion

In the end, filing the estate income tax may be unavoidable depending on circumstances. However, with proper planning, you can minimize the amount of taxable income. This will give more of your assets to your beneficiaries.

Recommended Reading:

Plan Your Estate– Plan Your Estate by Nolo will provide a more in-depth look at how to minimize taxable income to the estate.

Did you know of the estate income tax? Please, share your thoughts on the topic in the comment section.