Although we can’t escape death or taxes, we may be able to minimize the federal income taxes due on our final Form 1040. Filing a tax return after we die (we are then known as the “decedent”) is probably not something most of us think much about. But, a final Form 1040 generally must be filed for the year of our death and, just as in life, is typically due by April 15th of the following year. Normal tax accounting rules regarding the recognition of income and deductions generally apply for this final return. And, as is the case during life, tax planning opportunities are available both when death is imminent and after death. For instance, several decisions can affect the income or deductions reported on that final return. However, as we will discuss below, a major decision for married individuals concerns whether to file a joint return for the year of death.
When a married taxpayer dies and the surviving spouse does not remarry during the year, the spouse may file a joint return with the decedent for the year of death, but is not required to do so. The joint return will include income and deductions for the decedent prior to the date of death and the surviving spouse’s income and deductions for the entire year. If the surviving spouse remarries before the close of the tax year that includes the date of death, the spouse may not file jointly with the decedent. Instead, a separate return must be prepared for the decedent. Listed below are some of the advantages and disadvantages for joint filers to consider when filing that return.
Advantages of Filing a Joint Return. Since the surviving spouse’s tax year does not end upon the death of the decedent, it may be possible to reduce their combined income tax liability by accelerating or postponing income or deductions to maximize the use of the joint tax rates. Some other benefits include, but are not limited to: (a) use of one spouse’s excess deductions against the income of the other spouse (e.g., excess charitable contributions); (b) an increase in the IRA contribution limit (because of the spousal IRA rules); and (c) the ability of the decedent’s net operating loss (NOL), capital loss, and passive activity loss (subject to the limitation) carryovers to offset income of the surviving spouse. Note that any NOL or capital loss carryover of the decedent that is not used on the final return (whether separate or joint) will expire unused.
Disadvantages of Filing a Joint Return. Filing a joint return with surviving spouse is not always the best option. One disadvantage of filing a joint return for the decedent’s final tax year is that the decedent’s estate and surviving spouse are jointly and severally liable for any tax, interest, and penalties due on the joint return. In addition, when the surviving spouse is not the sole beneficiary of the estate, the decedent’s personal representative may not be willing to expose the estate to potential unknown liabilities (e.g., tax on the surviving spouse’s unreported income). Potentially, this exposure may be avoided because of the innocent spouse rules. Also, filing a joint return can negatively impact the amount of the decedent’s deductions that are subject to adjusted gross income (AGI) limitations (e.g., medical, casualty, miscellaneous itemized) since AGI is based on joint income rather than separate income. Finally, the surviving spouse must cooperate with the decedent’s personal representative by sharing the information necessary to prepare the return and by signing the return once it is prepared.
Planning for that final 1040 is something we may not think much about, but it is a good idea all the same.