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Understanding Death and Taxes

Benjamin Franklin famously wrote, “in this world nothing can be said to be certain, except death and taxes.” And the latter does not cease upon the former. Death introduces a number of tax issues that must be dealt with as part of your estate. Proper estate planning can help ease the burden, however, and minimize tax difficulties arising from an uncertain world.

Income Taxes

Your estate must still file a final individual income tax return-the common federal Form 1040 or California Form 540-for the tax year you die. This return should only reflect the income and deductions accrued through the date of death. Any income or losses earned after your death are credited to your estate.

An estate or trust is a separate legal and taxable entity from your person. The executor of your estate, or the successor trustee of your trust as the case may be, must therefore file a separate fiduciary income tax return-known as Form 1041-to record any taxable income earned after your death. This would include any profits earned from a business that remains in operation after your death, interest accrued on bank accounts, dividends paid on your stock holdings, and rents paid on real property. Until your estate is able to distribute all of your assets to the intended beneficiaries, the IRS will hold the estate (or trust) responsible for managing these assets and paying the necessary income taxes. The estate or trust must also file a separate California fiduciary income tax return, which is known as a Form 541.

Gift and Estate Taxes

California does not impose any separate taxes on estates, gifts or inheritances. But there is a “unified” federal gift and estate tax. Under the unified tax rules for 2014, a person may transfer by gift-that is, during his or her lifetime-or inheritance up to $5.34 million with no tax liability. This means, for example, if you make $2 million in gifts to your children during your lifetime, you may still leave up to $3.34 million to them in your will without having to pay either gift or estate tax.

Actually, most gifts you make during your lifetime are excluded from tax. Each year, you may give up to $14,000 in gifts without having to report them to the IRS. Gifts made from one spouse to the other are also excluded in their entirety, as well as gifts made to political or charitable organizations and gifts made to pay another person’s medical or educational expenses.

And while there is no state-level estate tax in California, some states continue to impose such levies. If you own real property in a state where a state-level estate tax still applies, your trust or estate may still have to file returns even for that state. This is because some states have a lower gift-and-estate tax exemption than the federal exemption of $5.34 million.

Planning Ahead Can Save Money

These are just some of the tax issues you need to consider as part of your estate planning. A qualified California estate planning attorney can provide you with a more detailed overview of the potential tax traps your trust or estate may face. Contact the Law Office of Scott C. Soady in San Diego today if you have any questions.

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