May 22, 2013
In addition to merely reporting the estate's income, as well as its gains and losses, certified public accountants owe it to their clients to create for them the best and most favorable tax situation available. This is done by pursuing a wide variety of tax exemptions, deduction programs, and other incentives, offered on an annual basis by the Internal Revenue Service. All estates will not qualify for the same exemption and deduction programs, but it bears reviewing the exact programs that may apply to each estate based on that estate's overall status.
1. The Standard Deduction
The standard deduction for personal income taxes is currently upwards of $5,000 per filer. This is significantly lower for estates, where the standard deduction used by the government totals just $600. This amount coincides with the threshold mentioned earlier, under which a Form 1041 would not need to be filed for any estate that earned $600 or less in the year prior.
Generally, the standard $600 deduction is claimed on every Form 1041 as a matter of fact, and this serves as the launching point for much more favorable exemptions or deductions that can result in a significant reduction of the estate's overall tax burden.
2. Charitable Contributions
If the decedent’s will states that a portion of the estate must be donated to charity, that donation will be treated as a tax-exempt charitable contribution that can reduce the estate's overall tax burn. The key thing to understand, however, is that any such contribution must be set forth in the decedent's will. If no such requirement is listed, then the contribution will not be considered exempt from federal taxation, even if all beneficiaries agree to use the estate's funds for such a donation independent of the will.
Furthermore, the charitable contribution made must be paid solely out of the income earned by the estate, and not from the value of the estate's holdings. Only contributions made from annual income can be deducted. Otherwise, they are simply not eligible for the exemption and deduction program.
3. Losses
Estates can usually claim a tax deduction for numerous kinds of losses experienced by the estate over the course of the year, the most common of which is loss associated with the depreciation or destruction of a property contained within the estate. Generally, losses are broken down into several distinct categories:
- Property Losses: These losses are associated with the devaluation of a property during the time between a decedent's death and the transfer or sale of that property to another party.
- Net Operating Losses: The losses experienced by a decedent's surviving business can be claimed as a reduction in estate income.
- Casualty and Theft: Any casualties or theft that devalues the estate's assets can be deducted from the estate's annual amount of income.
- Carryover Losses: Any operating losses, property depreciation losses, or other obligations incurred by the decedent immediately prior to their death can be deducted from the estate's income on the first Form 1041 filed by the accountant.
4. Expenses
It's possible to claim a tax deduction or exemption for any business-related expenses that occurred both prior to the decedent's death and afterward, in the administration of the estate. This must be filed as part of the Form 1041 preparation process, and a duplicate copy of these expenses must be filed and authorized by the person administering the estate or representing the beneficiaries. If both copies are not filed, tax adjustments will be made and any expense exemptions will be retroactively eliminated by the Internal Revenue Service.
5. Depreciation
Any depreciation that occurs between the time of the decedent's death and the time during which the Form 1041 is submitted can be claimed both by the estate and by beneficiaries who received depreciated income or assets from the estate. Such deductions are represented on Form 1041 in full and on form 1040 by individual taxpayers relative to their total depreciated inheritance from the estate.
6. Distributed Income
The function of an estate is typically to distribute income to one or more beneficiaries, typically made up of surviving family members or friends who have outlived the decedent. This distributed income from the estate can be claimed on Form 1041 by the accountant, allowing for a significant reduction in the amount of an estate’s overall annual earnings at the time of filing.
It should be noted, however, that any estate tax paid cannot be deducted. Likewise, it is virtually impossible for any capital gains taxes to be deducted as part of this process. Capital losses and any tax-exempt interest earnings both must be excluded from this deduction program as well.
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