If you’re serving as the executor or administrator for an estate, you may be wondering how probate finances work. How do you pay for probate? Is money you spend tax deductible? Will you be reimbursed?
Here’s the first thing to understand: the estate is responsible for any costs associated with probate, not you as an individual. Also keep in mind that every situation is unique and your tax requirements may vary, but the following are some general guidelines.
When we’re talking about tax-deductible probate fees or the cost of estate administration, we’re talking about the income tax return for the estate. You as an individual cannot deduct estate administration expenses on your personal tax return. Why? Because personal legal fees are not tax-deductible for individuals.
So what can you deduct on an estate tax return? Are probate fees tax deductible? Are funeral expenses tax deductible? Let’s start with a little background.
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Filing tax returns during probate
One of your responsibilities as the executor of an estate is to file the final tax return for the deceased individual. You’ll file the tax return — generally using IRS Form 1040 — as if they were still alive, and you’ll report any income they received until the date of their death.
Just like on a regular tax return, you can also list any credits or deductions they would have been eligible for. If they receive a tax refund, that money flows back into the estate.
You may also be responsible for filing an estate tax return on behalf of the estate. The U.S. government treats estates as separate legal entities from the deceased, and the tax return you file has a specific name: a fiduciary return.
You are required to file a fiduciary return (using IRS Form 1041) about 11 months after the month of death if the estate generated $600 or more of gross income during the tax year. You’ll have to file again for any tax year that the estate remains open, as long as the estate generates the income limit.
How can an estate generate income? Common sources of income include rental properties, profits from businesses owned by the estate, and interest from savings accounts, CDs, and bonds. Through investment properties or accounts, unpaid salary, or the sale of real estate. A fiduciary return may also be required if the estate sells any assets, such as real estate. Even if there is no income from the sale, it may generate a capital gain that needs to be reported to the IRS. In many cases, only a small portion of the proceeds are subject to income tax and that majority of the proceeds often pass to beneficiaries free of income tax.
You also have to file a fiduciary return if any beneficiary of the estate is a nonresident alien.
Deductions on fiduciary returns
As with personal income tax returns, there are many deductible expenses that can help reduce taxes owed. Many of these expenses can be dedicated either against the estate tax or the income tax, but not both. With the current estate tax threshold, only a small number of estates have to worry about estate tax so most focus deductions against income tax.
These deductions can be important as some executors are surprised to find that the estate may owe more income tax than expected and deductions can help reduce that.
Are funeral expenses tax deductible?
Yes, the estate can deduct funeral expenses that it has paid for. That means the estate has to reimburse any individual who helped cover the cost of funeral expenses before it can deduct those funds. If you have to pay the funeral home upfront because the estate funds aren’t available yet, the estate must reimburse you.
An estate can deduct funeral and burial expenses, such as the cost of moving the body, the cost of the tombstone and burial plot, and the cost of a memorial service.
Are estate administration fees tax deductible?
If you incurred expenses managing the estate, you can deduct those on the estate’s tax return. These might include costs like attorney or accountant fees or the cost to use a service. The estate can also deduct any executor fees it paid you for the services you provided as personal representative of the estate. Note, that these fees may be considered income to be reported on your personal income tax returns.
Filing an estate income tax return — a fiduciary return — can be complicated if you’re dealing with a large or complex estate. Reach out to an accountant or tax advisor if you’re concerned about the accuracy of your return.
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