chapter 8 3:30 – 4:00pm estate income tax issues and ... · chapter 8 3:30 – 4:00pm estate...

CHAPTER 8

3:30 – 4:00pm

Estate Income Tax Issues and Washington State Estate Tax

Stephen L. McDonald

Reed Longyear Malnati & Ahrens PLLC

PowerPoint distributed at the program and also available for download in electronic format: 1. Estate Income Tax Issues and Washington State Estate Tax Electronic format only: 1. Estate Income Tax Considerations Electronic versions of these documents are available on the KCBA website:

https://www.kcba.org/cle/EventDetails.aspx?Event=51013

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Estate Income Tax Issues and Washington State Estate Taxg

Stephen McDonaldReed Longyear Malnati & Ahrens PLLC

KCBA: Personal Estate Planning for the 99%May 10, 2013

Income Taxation of Estates and Trusts

• Generally

– Taxed in the same manner as individuals except as otherwise provided in subchapter J of the IRC

• Taxable Year• Taxable Year

– Trusts must use calendar year

– Estates may select calendar year or fiscal year

Income Taxation of Estates

• Taxes that must be considered and/or addressed by the administrator or personal representative of a decedent:

– Income tax– Income tax

– Estate tax (federal and estate)

– Gift tax

– Generation skipping transfer tax

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Income Taxation of Estates

• Conceptualize it like this

– At death, there is a new taxpayer born – the decedent’s estate

• Just like any other taxpayer• Just like any other taxpayer

– Each year, estate must calculate income, take deductions and exclusions and pay tax

Income Taxation of Estates –Deductions

• General rule

– Trusts and estates are entitled to deductions allowed to individuals, with exceptions

– Look to see if it is a deduction allowed to anLook to see if it is a deduction allowed to an individual, then see if there are any limiting provisions in Subchapter J


• Stated broadly, an estate or trust may deduct expenses and losses if they relate to:

– An activity engaged in for profit, or

The Code allows deductions for such activity– The Code allows deductions for such activity whether or not it is engaged in for profit.

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• Examples of allowable deductions for trusts and estates include expenses related to:– § 162: Ordinary and necessary expenses incurred in a trade or business

– § 212: Production of income

– § 163: Interest

– § 164: Taxes

– § 165: Losses

– § 166: Bad debts


• Examples of allowable deductions for trusts and estates include expenses related to (continued):

– §§ 167 168 611 642(e): Depreciation and– §§ 167, 168, 611, 642(e): Depreciation and depletion

– § 642(c): Charitable contributions

– §§ 172, 642(d): Net operating losses

– § 199: Qualified Domestic Production Activities


• Not all deductions/expenses allowed to individuals are able to be used by estates and trusts. For example:

– Standard deduction– Standard deduction

– Election to expense the cost of certain depreciable assets

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Filing Income Tax Returns

• Year of decedent’s death: two returns

– Form 1040

• Decedent’s income for year of death

– Form 1041Form 1041

• Estate’s income for the remainder of the year

Filing Income Tax Returns – Tax Rates

• Progressive, like with individuals, but different

– Starting in 2013, maximum income tax rate of 39.6% for individuals kicks in at $400,000

– However for trusts and estates the top rate ofHowever, for trusts and estates, the top rate of 39.6% kicks in on income over $11,950

Filing Income Tax Returns – Tax Rates

If Taxable Income Is: The Tax Is:• Not over $2,450 15% of TI

• $2,450.01 to $5,700 $367.50 + 25% of excess over $2,450

$ $ $• $5,700.01 to $8,750 $1,180 plus 28% of excess over $5,700

• $8,750.01 to $11,950 $2,034 plus 33% of excess over $8,750

• Over $11,950 $3,090 plus $39.6% of excess over $11,950

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Filing Income Tax Returns – Net Investment Income (“NII”) Surtax

• Big change for 2013 . . . Net Investment Income Surtax

• 3.8% surtax imposed on the lesser of:• a Net investment income or• a. Net investment income; or

• b. The excess of the taxpayer’s Form 1040 modified AGI over a threshold of $200,000 ($250,000 if MFJ) and $11,950 for estates & trusts

– Only undistributed NII of an estate or trust is subject to 3.8% tax, subject to limitation

Filing Income Tax Returns – Calculation of Net Investment Income

• Net Investment Income is the sum of:

– Gross income from interest, dividends, annuities, royalties, and rents, unless derived in the ordinary course of business;

– Income from a business in which the taxpayer does not materially participate and business income from trading; and

– Capital gains and other net gains from the disposition of property, except to the extent attributable to property held in a material participation business.

Filing Income Tax Returns – NII Tax

• Planning Tip ‐ Distribute!

– If beneficiaries aren’t subject to the NII tax and also are not subject to the top individual rate, there is an incentive for the fiduciary to distribute yAGI in excess of the top rate threshold.

– The special rule allowing amounts paid or credited within the first 65 days of any tax year of an estate or trust as paid on the last day of the prior tax year is helpful in this regard.

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Filing Income Tax Returns – Net Investment Income Tax

• Application of 3.8% tax to an Electing Small Business Trust (ESBT)

– An ESBT is a trust that holds the stock of an S corporation and has met the eligibility and election rules of Sec. 1361(e).

– To the extent of the trust’s share of net income of the S corporation, the trust must pay a top 39.5% tax rate on that income. The ESBT is not permitted to consider any distribution deductions in reducing the S corporation income subject to this 39.6% rate tax

Filing Income Tax Returns – Net Investment Income Tax

• Example: Calculating the 3.8% tax of a trust• FACTS

– For 2013, the Longyear Trust, a calendar year complex trust, has $21,950 of interest, dividends, and other investment income.

– The 39.6% rate threshold for 2013 is $11,950, and the trust made no distributions during 2013.

• RESULT:– The Longyear Trust incurs $380 of net investment income tax on $10,000 of AGI exceeding the rate threshold

• ($21,950 AGI ‐ $11,950 rate threshold for 2013)

Filing Income Tax Returns – Procedure

• At the outset, the personal representative should file:

– Form SS‐4

• Authorization to file for EIN for the estateAuthorization to file for EIN for the estate

– Form 56

• Perhaps two copies – one for the decedent and one for the estate

– Form 4810

• Request for Prompt Assessment

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Filing Income Tax Returns – Procedure

• Personal representative should also:

– Notify IRS of fiduciary relationship

• Allows IRS to mail all tax notices concerning the decedent or the estate to the personal representative

– Request prior returns

• Form 4506: Request for Copy of Tax Return

– Request discharge from personality liability

Decedent’s Final Income Tax Return

• Filed after the year of death, accounts for only the portion of the year that the decedent was alive.

• Before filing the return there are several• Before filing the return, there are several issues that the personal representative should consider . . .

Decedent’s Final Income Tax Return:Joint Return

• Joint return with surviving spouse?

– May lower effective tax rate

– Surviving spouse can take advantage of the decedent’s exemption and certain deductionsdecedent s exemption and certain deductions

– Surviving spouse must not be NRA

• Big potential drawback to joint return

– The personal representative is jointly and severally liable with the surviving spouse for all items on the return

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Decedent’s Final Income Tax Return:Medical Expenses

• Generally

– Deductible on either the decedent’s final return or the estate’s return so long as paid within a year of the decedent’s death

– Keep in mind 7.5‐percent floor for medical expenses to be deductible for income tax

• Planning tip

– Claim on estate’s return if estate tax is due, otherwise claim on decedent’s return

Decedent’s Final Income Tax Return:Tips & Reminders

• Write “DECEASED,” the decedent’s name, and date of death across the top of the final return

• Necessary signatures– PR, as well as SS if a joint returnIf no PR exists and SS is filing joint return SS must sign– If no PR exists and SS is filing joint return, SS must sign and write “Filing as Surviving Spouse” in the signature area

• Due date– Filing and payment due on April 15th

– Extensions for filing and hardship exemptions for payment are available

Estate’s Income Tax Return

• Form 1041

• Due Date:– 15th day of the 4th month following the close of the estate’s tax yeary

• Fiscal or calendar tax year?– Can elect either

• Why choose fiscal?– Beneficiaries may benefit from being able to defer reporting income

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Estate’s Income Tax Return

• Estimated payments

– Not required for first two years

• Trusts

l ll i f h– Trustee may elect to treat all or any portion of the payment as made by a beneficiary or beneficiaries under § 643(g)

– Trustee has 65 days after the end of the taxable year to make the election on Form 1041‐T

Estate’s Income Tax: RLTs & § 645

• The election

– Allows an executor to treat the decedent’s RLT as part of the estate for federal income tax purposes

• Election can remain in effect from the date of• Election can remain in effect from the date of the decedent’s death until:

– Two years after the decedent’s death if no estate tax return is required

– Six months after final determination of estate tax liability if an estate tax return is required

Estate’s Income Tax: RLTs & § 645

• Benefits to the election:

– As part of the estate, the trust can now have a fiscal year

– The RLT won’t be required to make estimated taxThe RLT won t be required to make estimated tax payments for two years after death

– Flexibility with holding S Corporation stock

– Increases allowable personal exemption to $600

– Tax return consolidation

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Administrative Expenses

• The rule:

– All expenses other than personal expenses of the decedent may be allocated to either the estate’s estate tax return or the estate’s income tax return.

• Where should you deduct them?

– Due to higher tax rates, it is generally better to take these on the estate tax return if there is any estate tax due

– If not, claim them on the income return


• Tips for Planning:

– Allocate deductions for administrative expenses strategically. Treas. Reg. § 1.642(g)‐2 permits for very flexible allocation methods, as far as splitting y , p ga single expense between both returns


• Procedure for claiming on income tax return:

– Best practice: attach statement to the return that waives the right to claim the same expenses as deductions on the estate tax return

– If the statement is not attached to the return, the administrator has until the statute of limitations for the taxable year of that return expires to file the statement

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Income in Respect of a Decedent (IRD)

• Generally– Most property transferred at death gets a stepped‐up basis in the hands of the transferee

– Step‐up basis treatment is denied to property that constitutes a right to receive “income in respect of a decedent” under § 691

• What happens instead?– These items are includible in the decedent’s estate for estate tax purposes and treated as gross income for the recipient when later realized


• What constitutes IRD?

– Generally, IRD items must have accrued to the cash basis taxpayer but not actually or constructively received while alivey

• Underlying policy:

– To provide parity of income tax treatment between cash basis and accrual basis taxpayers


• Examples of IRD items:

– Salary and fringe benefits accrued at death

– Fees and commissions based on services that are measured by transactions occurring after deathmeasured by transactions occurring after death

– Enforceable right to receive amounts under deferred compensation arrangement

– Retirement plan payments

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• Examples of IRD items ‐ continued:

– Dividends declared before death but paid after death

– Interested owed to decedentInterested owed to decedent

– Certain payments for rent

– Certain payments due from business interests

– Income element of installment sales proceeds

– Alimony

IRD Planning Tip

• Problem:

– IRD income is subject to income tax and is brought back into the estate, thus, it is potentially subject to both taxes

• Solution:

– Charitable gifting. Now, the IRD item gives both an estate tax deduction and is excluded from the gross income of the taxpayer for income tax purposes

Deductions in Respect of Decedent

• Rule:

– Certain deductions that are not properly allowable on the decedent’s last income tax return are instead allowed on the income tax return of the decedent’s estate in the taxable year when paid

• Successor‐in‐Interest

– Can take advantage of this so long as the obligation to pay is imposed on them

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• May deduct Deductions in Respect of Decedent on both estate tax return and fiduciary’s income tax return

– The general rule that expenses may not be– The general rule that expenses may not be deducted on both the federal estate tax return and the fiduciary income tax return doesn’t apply to deductions in respect of a decedent


• Planning tip

– If deductions in respect of a decedent exceed gross income, arrange to take them on the final income tax return of the estate rather than an earlier one

– The excess deductions on the final return are allocable to estate beneficiaries on the termination of the estate


• Deduction for Estate Tax

– Estate tax attributable to the inclusion of income in respect of a decedent on a federal estate tax return is deductible

– Taken by the taxpayer who includes the IRD item in gross income

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Washington Estate Tax

• Overview

– A “stand‐alone” estate tax, which means that it isn’t impacted by changes to the federal estate tax, though it incorporates some of its provisions

• As it stands today

– Only estates valued at $2 million or more are required to file an estate tax return – RCW 458‐57‐115

– Rates:

• Lowest: 10% (on estates from $0 to $1 million)

• Highest 19% (on estates above $9 million)

Washington Estate Tax –Determination of Gross Estate

• Form to File

– WA Estate and Transfer Tax Return (WT)

• Required Supporting Documents

C f h f d l 06 if fil d– Copy of the federal 706 return, if filed

– Copy of death certificate

– Certified copy of the will, if one exists

– Supporting valuation documentation

– Payment, if tax is due

Washington Estate Tax –Determination of Gross Estate

• Tax base

– Starting point: Gross estate

• Gross estate the value of all the decedent's tangible and intangible property at the time of death

• Determined in the same manner as the federal estate, with a few adjustments

– Next: Take deductions to arrive at Taxable Estate

– Finally: Multiply by appropriate rate, take any applicable credits, arrive at tax due

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Washington Estate Tax – Gross Estate

Examples of Washington‐specific rules for determining gross estate• Funeral expenses for married decedents

– Funeral expenses reported for a married decedent– Funeral expenses reported for a married decedent must be halved.

• Mortgages and liens on real property– Real property listed on Schedule A must be reported at its fair market value without deduction of mortgages or liens on the property.

Washington Estate Tax – Gross Estate

Examples of Washington‐specific rules for determining gross estate• Washington qualified terminable interest (QTIP) election

– A personal representative may choose to make a larger or smaller QTIP election than the election taken for federal estate tax purposes to reduce Washington estate tax liability whiletax purposes to reduce Washington estate tax liability while making full use of the federal unified credit.

– Irrevocable, and the surviving spouse receiving the QTIP property must include the value of the remaining property in his or her gross estate.

• Qualified domestic trust– A deduction is allowed for property passing to a surviving

spouse who is not a U. S. citizen through a qualified domestic trust.

Washington Estate Tax

Determining gross estate when decedent owned property located inside and outside Washington

• Use the fractional approach

N t l f th t l t d i– Numerator = value of the property located in Washington

– Denominator = value of the decedent's gross estate

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WA Estate Tax ‐ Filing Requirements: Timing

• General rule– A Washington estate tax return must be filed if a federal return is required to be filed or if the gross estate exceeds $2 million.

• If a federal return is required to be filedh b f l d b h d h f d l– A Washington return must be filed by the date the federal

return is required to be filed, including any extension of time for filing.

• If no federal return is required to be filed – The Washington return must be filed by the date a federal return would have been required to be filed (nine months after the decedent's death), including any extension of time for filing.

WA Estate Tax ‐ Filing Requirements: Payment

• Payment of the Washington tax must be made by the due date for filing the Washington return, without regard for extensions.

• A return that is postmarked by the due date p y(including extensions) will be considered timely. Payment is considered timely made if postmarked within the time allowed for making the payment, including any extensions.

WA Estate Tax ‐ Filing Requirements: Extension to File Return

• If federal estate return is required:– An extension of time for filing a return may be granted for federal estate tax purposes, although generally not for more than six months.

An extension of time for the federal filing– An extension of time for the federal filing automatically extends the state deadline.

– The person responsible for filing the Washington return must file a copy of the federal extension by the due date of the Washington return, or within 30 days of issuance of the federal extension, whichever is later.

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WA Estate Tax ‐ Filing Requirements: Extension to File Return

• If only Washington estate return is required, not federal:– An estate that is required to file a Washington return but not a federal return can get a one‐time,

f f6‐month extension of time to file the state return.

– The personal representative must apply to the Department of Revenue in writing, prior to the original filing deadline, and must acknowledge that interest will continue to accrue from the original due date.

WA Estate Tax ‐ Filing Requirements: Extension to Pay

• If federal extension to pay is granted:

– A person who obtains an extension of time for payment of the federal tax or who elects to pay tax in installments may elect to pay the y p yWashington estate tax in the same manner and within the same time period.

– A copy of the federal extension must be filed by the later of the original due date or 30 days after the issuance of the federal extension.

WA Estate Tax ‐ Filing Requirements: Extension to Pay

• No federal return due:– An estate that is required to file a Washington return but not a federal return may be able to get a payment extension in cases of undue hardship, so long as there has been no fraud, negligence, or intentional disregard of laws and regulations, or for a payment plan for closely heldand regulations, or for a payment plan for closely held businesses.

– The granting of an extension of time to pay the tax owed or for a payment plan for closely held business will not operate to prevent the running of interest.

– The extension cannot exceed one year from the original due date for any 1 period, or 4 years from the original due date for all periods.

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WA Estate Tax ‐ Filing Requirements

• Extension to pay tax

– Federal law may permit payment plans, which can involve 5‐year deferrals and payments over 10‐year periods, when estates consist largely of y p , g yinterests in closely held businesses. [IRC §6166 .] Washington follows these provisions for purposes of its estate tax. [ Wash. Admin. Code §458‐57‐135(3)(c)(v).]

WA Estate Tax ‐ Filing Requirements: Amended Returns

• If a federal estate return is also amended:– An amended Washington estate tax return must be filed within

5 days of filing an amended federal return. – A copy of the federal amended return must be filed along with

the amended state return.

• If no federal estate return is filed:If no federal estate return is filed:– An amended return of an estate that is not required to file a

federal return must be received within 3 years of the date the original Washington estate tax return was filed, or within two years of the date the Washington estate tax was paid.

– A written notification must be filed with the Washington Department of Revenue if the amount of federal tax due is adjusted or there is a final determination of federal tax due.

WA Estate Tax ‐ Filing Requirements: Refunds

• If estate taxes are overpaid, the personal representative of the estate or the representative's counsel may ask for a refund by filing a claim with the Department of Revenue.

• Interest is paid on overpayments from the date the overpayment was received until the refund is mailed, if the refund application was filed within 120 days months of finalrefund application was filed within 120 days months of final determination. If the refund application was filed more than 120 days after final determination, interest is paid only for the 120‐day period.

• Generally, no refund shall be made for taxes, penalties, or interest paid more than 4 years prior to the beginning of the calendar year in which the refund application is made or an examination of records is complete.

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WA Estate Tax ‐ Filing Requirements: Interest & Penalties

• Interest – Any portion of the estate tax not paid when due bears interest until

paid.

• Civil penalties – Late filing penalty: The person responsible for filing the return

may be subject to late‐filing penalties of 5% of the tax due formay be subject to late filing penalties of 5% of the tax due for each month (capped at the lesser of $1,500 or 25% of the tax) if the return is filed late.

– Penalties are pro‐rated for any portion of a month. A pro‐rated penalty is calculated by:

• (1) dividing the monthly rate by the days in the month, to yield a daily penalty rate;

• (2) multiplying daily penalty rate by number of days delinquent in the month; and

• (3) multiplying the result by the amount of delinquent tax.


• Waiver of late‐filing penalty: – The Department can waive a late filing penalty if the failure to

file when due was caused by circumstances beyond the control of the responsible person.

• Examples of circumstances that may qualify for a waiver include, but are not limited to:include, but are not limited to:– Death or serious illness of the person responsible for filing the

return, or a member of his or her immediate family.– The unexpected and unavoidable absence of the person

responsible for filing the return.– The destruction of records necessary to file the return as a

result of fire or other casualty.– Incorrectly filing the return with another state due to an issue of

the decedent's domicile or mistakenly sending it to the IRS.


• Criminal penalties

– Willful failure to file a Washington return or willful filing of a false return is a gross misdemeanor.

• Distribution or delivery of property. st but o o de e y o p ope ty

– A personal representative who distributes property without paying or arranging for payment of the estate tax, or furnishing security for payment, is personally liable for the tax due to the extent of the value of any property which has come, or will come, into the personal representative's possession.

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ESTATE INCOME TAX CONSIDERATIONS

May 10, 2013

Stephen McDonald

Reed Longyear Malnati & Ahrens PLLC 801 2nd Ave. Suite 1415

Seattle, WA 98104 (206) 624-6271

[email protected]

STEPHEN MCDONALD practices in the areas of estates and trusts, estate and tax planning, as well as other tax-related matters. He is also an adjunct faculty member at Seattle University's Albers School of Business, where he teaches corporate taxation, partnership taxation, and individual taxation. He is an associate with Reed Longyear Malnati & Ahrens PLLC in the areas of taxation law and estate planning. The following seminar materials are drawn from materials authored by the speaker and Claudia Gowan. Mr. McDonald gratefully acknowledges her expertise for these contributions.

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TABLE OF CONTENTS

INTRODUCTION INCOME TAXATION OF ESTATES AND TRUSTS FILING INCOME TAX RETURNS FOR THE INDIVDIUAL AND ESTATE TIPS FOR FILING A FEDERAL ESTATE TAX RETURN TIPS FOR FILING A STATE ESTATE TAX RETURN TIPS FOR FILNG A FEDERAL GIFT TAX RETURN WHEN TO PULL A REVOCABLE LIVING TRUST BACK INTO THE ESTATE ADMINISTRATIVE EXPENSES INCOME IN RESPECT OF A DECEDENT

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I. INTRODUCTION Everyone knows Benjamin Franklin’s well-known quote tat “[t]he only things certain in life are death and taxes.” As estate planning and tax practitioners, we know that these two things are not mutually exclusive; that is to say, death does not stop the government’s ability to tax an individual. In fact, some of the most confusing and mercurial tax provisions in the IRC relate to the taxes that apply at an individual’s death, including estate tax, gift tax, generation skipping transfer tax, and income tax. From an income tax perspective, what happens upon the death of an individual another taxpayer comes into existence – that individual’s estate. For every year that the estate is in existence, it has to prepare and file income tax returns, just like any other taxpayer. Thus, unless an individual dies at midnight on December 31st, for the year of death, not only will the administrators of the estate have to contend with all of the other issues that come along with death, like probate, estate tax, gift tax, GST tax, etc., but they will also have to file two income tax returns – one for the individual and one for the estate. It should be clear from the most seasoned estate planner to the most novice that dealing with post-mortem tax matters can be a difficult and confusing process. This CLE is intended to present a brief overview of common income tax-considerations that may arise when both advising on and directly handling post-mortem tax matters. Though the talk focuses exclusively on income and Washington estate tax issues, these printed materials also touch on related gift and federal estate tax considerations. II. FILING INCOME TAX RETURNS FOR DECEDENTS AND ESTATES As was stated above, during the year of an individual’s death, two federal income tax returns are required. For the decedent, the personal representative for the estate will need to file Form 1040 to report the decedent’s income for the tax year that the individual was alive. Similarly, for the estate, the personal representative will need to file Form 1041 to report the decedent’s estate income for the remainder of the year. Both individuals and estates are subject to progressive tax rates, but there are significant differences in the rates applied to both. Specifically, estates do not have the benefit of a 10-percent tax bracket, and the other brackets for estates are substantially thinner than they are for individuals. For example, in 2013, the threshold for the highest tax rate of 39.5 percent is only imposed on individuals who earn $400,000 or more of taxable income. Conversely, an estate will be taxed in the 39.5-percent bracket after just $11,950 of income. There are three primary forms that a personal representative needs to consider filing at the outset of the process: Form SS-4, Form 56, and Form 4810. The first step that a personal representative should take when preparing to handle the income tax matters of the decedent and estate is to obtain an employer identification number (“EIN”) for the estate. This is a simple process that can be done online, but the IRS requires you to have a signed copy of Form SS-4 on file in order to obtain an EIN. Next, the personal representative should also file a Form 56, a Notice of Fiduciary Relationship, with the IRS. Form 56 provides notice to the Service of your fiduciary relationship and informs the Service of the address to send documentation and

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correspondence related to the estate and the decedent. Note that you will often need to file two separate Form 56 documents with the IRS – one for the estate and one for the decedent. Finally, the personal representative should also consider filing Form 4810, Request for Prompt Assessment. This election generally limits the assessment period to 18 months from the date of filing. Note, however, that it will not protect against claims of fraudulent returns, non-filing, or returns with “substantial omissions.” A. THE FINAL INCOME TAX RETURN OF THE DECEDENT The decedent’s final tax return, Form 1040, is due on April 15th of the year following death. This return includes all of the income recognized, deductions paid or incurred, and applicable exemptions attributable to the time prior to death. Income received and gains recognized after death generally belong on the estate’s first federal income tax return, Form 1041. 1. Filing a Joint Return With Surviving Spouse For decedents who were married at the time of death, the final return may be filed jointly with the surviving spouse. A joint return will include all of the decedent’s income and deduction items up to the date of death and all of the spouse’s income and deduction items for the entire taxable year. Filing a joint return may lower the effective tax rate, and it can allow the surviving spouse to take advantage of the decedent’s deductions and applicable exemptions. This option is not available if either the decedent or the surviving spouse is a nonresident alien. When filing a joint return, the personal representative becomes jointly and severally liable with the surviving spouse for all items on the joint return, so there may be little to gain and much to lose from following this tip. Deciding to not file a joint return with the surviving spouse will not be detrimental to the spouse given that the spouse is still eligible for the § 1(a) (married filing jointly) tax table for two years even if no joint return is made. 2. Medical Expenses The decedent’s medical expenses that are paid after death are deductible on either the decedent’s final return (as long as they are paid within a year of the decedent’s death) or the estate tax return, but not both. Obviously, if no estate tax is due, the decedent’s final return is preferable so that there is some tax benefit from the expenses. If estate tax is due, however, then it is generally preferable to claim the expenses on the estate tax return. For one thing, unlike the income tax, the estate tax does not impose a 7.5-percent floor before medical expenses become deductible. For another, as explained above in the context of allocable expenses generally, the estate tax is generally imposed at higher rates and is often due sooner than the income tax. The IRS has given its approval for fiduciaries to claim a portion of the medical expenses on the decedent’s final return and the rest on the estate tax return. See Rev. Rul. 77-357. This apportionment of the expenses can be very helpful if the 7.5 percent floor on the income tax renders some portion of the expenses non-deductible.

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B. THE ESTATE’S INCOME TAX RETURN The estate’s income tax return is due by the 15th day of the 4th month following the close of the estate’s tax year. Unlike trusts, estates are allowed to use a fiscal year for federal income tax purposes, and they may choose any fiscal year they want so long as the first taxable year does not exceed twelve months. Election of a fiscal year allows beneficiaries receiving taxable income to defer the reporting of income because income distributions are taxable in the year when the estate’s taxable year ends. Estates are relieved of the obligation to make estimated tax payments in their first two taxable years, but estates that remain open for a third taxable year may be required to make estimated tax payments. Thus, it is a good idea to close the estate before the third taxable year if at all possible. III. TIPS FOR FILING FEDERAL ESTATE TAX RETURNS: Form 706 A. Current Federal Estate and Gift Taxes Fundamentals of the federal tax relief, unemployment insurance reauthorization, and job creation act of 2010 (TRA 2010) have reshaped the federal estate, gift and generation skipping transfer tax regime.

1. Estate taxes. TRA 2010 implements significant changes in the applicable exclusion amount and estate tax rates, including re-unification of the estate and gift tax. Under the Act, each individual citizen is allowed an applicable credit amount against the tax imposed under IRC § 2001. The applicable credit amount is the amount of the tentative tax as determined under IRC § 2001(c) if the amount to which such tentative tax is to be computed were equal to the applicable exclusion amount. The applicable exclusion amount codified under § 2010(c) is set at $5,250,000.00 for 2013. The applicable exclusion amount is to be adjusted annually for inflation on estates of decedents dying in a calendar year after 2011. IRC § 2010(c)(2)(B). For purposes of calculating the adjustment, the Act stipulates that the applicable exclusion amount shall be increased by multiplying the applicable exclusion amount by the IRC § 1(f)(3) cost of living adjustment (the percentage by which the CPI for the preceding calendar year exceeds the CPI for the calendar year 2010.) Id. Amounts that are not multiples of $ 10,000.00 are rounded to the nearest multiple of $ 10,000.00. Id.

2. Gift Taxes The IRC § 2505 unified credit against gift tax is restored, effective for gifts made after December 31, 2010. IRC § 2505(a)(1)-(2). This means that at least for now, each individual has a lifetime exemption from gift tax of $5,250,000, and an estate tax exemption upon death of $5,250,000. The value of lifetime gifts in excess of the annual exclusion from gift tax and

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qualified payments of medical and educational expenses will reduce the available basic exclusion amount upon death. B. Filing

A Form 706 is due nine months after the date of death, with an automatic 6 month extension available on filing a Form 4768. For purposes of the estate tax, an extension of time to file any IRC §6018 return, make a tax payment or make a disclaimer is a date no earlier than nine months after the date of enactment of the Act. See, amendment notes to IRC § 2518(b.) Where any generation skipping transfer is made after December 31, 2009 and before the TRA 2010 was enacted, the filing date for any generation skipping transfer tax return is no earlier than nine (9) months after the date of enactment of TRA 2010, December 17, 2010. As part of the Taxpayer Relief Act of 2012, Congress extended the unified estate and gift exemption of $5 million per person, but subject to inflation indexing. Thus, for 2013, the exemption amount is $5.250,000. However, the rate of estate or gift tax on any transfers in excess of this exemption will be 40% rather than 35% rate applicable in 2012. C. DON’T MISS ANY APPLICABLE DEADLINE! Section 6018(a) of the Internal Revenue Code states that an estate tax return is required if the decedent’s gross estate, when combined with the “adjusted taxable gifts” the decedent made during life, exceeds the “applicable exclusion amount” under § 2010(c). Today, the applicable exclusion amount for federal purposes is $5,250,000. The federal estate tax return is due nine months following the decedent’s death. Section 6081 allows an extension of up to six months for filing a tax return (but not for paying the tax), and this includes the estate tax return. Extensions are quite common because appraisals may not be complete and there may be other assets to inventory. Even with all of the required information at hand, however, an extension may be a good idea if the surviving spouse might die before the end of the extension period. If the surviving spouse does die, it allows the personal representative to avoid making a full “qualified terminable interest property” (“QTIP”) election on the first spouse’s return. By equalizing the size of the taxable estates, less total tax is owed. IV. DEDUCTING EXPENSES: ESTATE TAX RETURN OR INCOME TAX RETURN? A wide variety of expenses are deductible for the estate, including court costs and filing fees, appraisal fees, commissions paid to fiduciaries, attorney and accountant fees, traveling expenses incurred in the administration of the estate, selling expenses, and storage and maintenance expenses. From a tax planning perspective, one of the most important issues for a taxable estate is whether to claim these types of expenses on the estate tax return or the estate’s federal income tax return. As a general rule, deductions are more helpful for estate tax purposes than for income tax purposes because the estate tax rates are typically higher than the income tax

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rates. Moreover, the federal estate tax is usually due before federal income taxes, so from a time value of money perspective, it is beneficial to claim deductions for estate tax purposes. If the estate will not be liable for federal estate taxes, however, the deductions should of course be claimed on the income tax return where possible. There are significant planning opportunities here because of the flexibility in allocating deductions. Generally, all expenses other than personal expenses of the decedent may be allocated to the estate tax return or the income tax return. The personal expenses of the decedent may only be claimed on the estate tax return, as personal expenses are generally not deductible for federal income tax purposes. Examples of these types of expenses include funeral expenses, federal income and gift taxes owed by the decedent but paid after death, expenses incurred by the decedent with respect to tax-exempt income, and personal expenses of the decedent paid after death. In Washington, funeral expenses are considered a “community expense,” thus only half of the funeral expenses may be claimed. Treasury Regulation § 1.642(g)-2 contemplates that the allocation of permitted expenses may be made on an item-by-item basis and, indeed, even a single expense can be allocated between the income tax return and the estate tax return. This provides tremendous flexibility and allows the estate to receive the full benefit of the permitted expense deductions. While the estate tax return may be the preferred location for most allocable expenses, as explained above, allocation to the income tax return is not necessarily a bad result. Keep in mind that most of the estate’s itemized deductions are spared from the two-percent “haircut” limitation in § 67. Section 67(e)(1) exempts such expenses paid by an estate or trust where the taxpayer can prove that such expenses would not have been incurred but for the fact that the property was held by the estate or trust. Case law suggests that payments for investment advice will not qualify for this exemption. See Mellon Bank v. United States (Fed. Cir. 2001) and Scott v. United States (4th Cir. 2003). In order to claim allocable expenses on the income tax return, a statement must be attached to the return that waives the right to claim the same expenses as deductions on the estate tax return. The waiver is irrevocable. See Treasury Regulation § 1.642(g)-1. The statement is valid if filed any time before the statute of limitations for the taxable year of that return expires, so statements prepared after the income tax return is filed can be accepted in most cases. A. CONSIDER VALUATION ELECTIONS 1. The Alternate Valuation Date Next, the fiduciary should determine whether to elect to use the “alternate valuation date” under § 2032. The alternate valuation date allows assets to be valued as of the date occurring six months after the date of death (or the date of sale, if earlier) instead of the date of death. The election is allowed only if the election actually causes a reduction in estate tax liability. (Why else would someone make the election, you ask? An estate well below the exemption amount

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would make the election if the values have increased so that the beneficiaries can claim an even higher stepped-up basis. This restriction prevents that game playing.) The election is very easy to make. The personal representative simply checks the box on the Form 706, near the top of page 2 (part 3, line 1) and the election is complete. The election applies to all property included in the gross estate (no picking and choosing) and is irrevocable. See § 2032(d)(2) and Reg. § 20.2032-1(b)(2). 2. Special-Use Valuation Another possible election is the special use valuation election in § 2032A. Normally, real estate is valued according to its “highest and best use.” That can work against farmers and others who use property in ways that are not in accord with the highest and best use of the property. Section 2032A thus permits real estate used in farming or other trade or business to be valued according to its actual use in the farming or business activity. The maximum reduction allowed through this provision is limited, though substantial, historically. There are several requirements for making use of § 2032A. Basically, they are these: (1) the decedent must have been a United States citizen or resident at death; (2) the real property must be located in the United States; (3) the property must pass to one or more “qualified heirs” (defined to include most family members;) (4) at the time of the decedent’s death, the property must have been used by the decedent or family members for farming or business purposes (what the statute calls a “qualified use”;) (5) more than half of the value of the gross estate must consist of real and/or personal property used in a “qualified use” and such property must also pass to a “qualified heir;” (6) at least one-fourth of the gross estate must consist of real property used for a “qualified use” for five of the eight years prior to the decedent’s death, and the decedent or a family member must have materially participated (i.e., on a substantially full-time basis) in such qualified use during such times; and (7) the qualified heirs must sign a recapture agreement that requires them to pay all or a portion of the estate tax savings if the property is sold within (or not used in a qualified use for) ten years of the decedent’s death. Unlike the alternate valuation date election, the § 2032A election is bit more complicated. The paperwork required to make the election appears on Schedule A-1 of the estate tax return (six pages in length). If the election is made, the § 1014 basis step-up for the beneficiaries is limited to the special use value. § 1014(a)(3.) B. INSTALLMENT PAYMENT OF ESTATE TAXES Section 6166 allows installment payment of estate taxes attributable to a closely-held business (from two to ten equal annual payments) starting five years after the due date for the federal estate tax return at a reduced rate of interest. The interest must be paid over the life of the term. The interest is not deductible. To qualify for this benefit, the decedent must have been a United States citizen or resident. The decedent’s interest in the closely-held business must comprise more than 35 percent of the decedent’s “adjusted gross estate.” The business must be an active one; passive

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investment entities will not qualify for this benefit. If the business is a corporation, the decedent must have held at least a 20 percent stake and the corporation cannot have more than 15 shareholders. Likewise, if the interest is a partnership, the decedent must have held at least a 20 percent stake and the partnership cannot have more than 15 partners. The deferral of estate tax is lost if payment of an installment is six months late. If the payment is late by less than six months, deferral is still available but the two percent interest rate is lost and the estate owes a five percent penalty. Deferral is also lost if the beneficiaries of the business interest(s) dispose of such interest(s) before the last installment payment is complete. C. PORTABILITY OF UNUSED EXCLUSION AMOUNTS Effective for decedents dying and gifts made after December 31, 2010, a surviving spouse may add the unused exclusion amount of a predeceased spouse to the surviving spouse’s exclusion amount for purposes of determining the applicable credit amount to implement for the surviving spouse’s estate. IRC § 2010(c.) The ability to take advantage of unused exclusion amounts is limited to the unused exclusion amount of deceased spouses dying after December 31, 2010 and the surviving spouse’s “last” deceased spouse. Id. IRC § 2010(c) was amended by TRA 2010 to provide that the applicable exclusion amount is the sum of the basic exclusion amount, and in the case of a surviving spouse, the deceased spousal unused exclusion amount. The basic exclusion amount in 2013 is $5,250,000. Id., § 2010(c)(3.) The allowable unused exclusion amount is defined as the lesser of the basic exclusion amount, or, the excess of the basic exclusion amount of the last deceased spouse over the amount with respect to which the tentative tax is determined under IRC § 2001(b)(1) on the estate of such last deceased spouse. Id., § 2010(c)(4.) Under these provisions, a new term is introduced: basic exclusion amount. The basic exclusion amount is set at five million dollars and adjusted for inflation in the case of any decedent dying after 2011. Id., § 2010(c)(3)(A)-(B.) The inflation adjustment formula is $ 5,000,000.00 multiplied by the IRC § 1(f)(3) cost of living adjustment (the percentage by which the CPI for the preceding calendar year exceeds the CPA for the calendar year 2010.) Id. Amounts that are not multiples of $ 10,000.00 are rounded to the nearest multiple of $ 10,000.00. Id. It is not necessary for a testator or trustor to authorize a surviving spouse to use the portability provisions under their testamentary documents, e.g. no affirmative act is necessary by the decedent. The decision to reserve any unused basic exclusion amount is made at the time of death of the first spouse to pass away – generally on a post-mortem basis. Id., § 2010(c)(5.) In order to use the unused basic exclusion amount of a predeceased spouse, the executor of the estate of the first spouse to pass away must file a Form 706 estate tax return computing the unused amount of the available basic exclusion and make an election on the return reserving the unused exclusion for the surviving spouse. Id., § 2010(c)(5)(A.) The IRS recently issued Notice 2011-82, which provides in part that all an executor need do to elect portability of any unused exclusion amount is file a Form 706, e.g. there will be no ‘check the box’ or other formal

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election requirements. The election is irrevocable. Id. The election may not be made retroactively, e.g. an election is specifically prohibited unless the return is timely filed (including any applicable extensions.) Id. Further, for purposes of this election, and in spite of any statute of limitations on assessment and collections applicable under IRC § 6501 that may otherwise apply, an examination of the return appears to be allowed at any time in order to make a determination with respect to the unused exclusion amount. Id., § at (c)(5)(B.) However, the generation-skipping transfer tax exclusion amount of a surviving spouse is limited to the $5,250,000.00 exclusion each individual is allowed. TRA 2010 specifically provides that IRC § 2631(c) is amended by replacing the term “applicable exclusion amount” with “basic exclusion amount.” Id., § 2631(c.) Here, whether or not wife used her generation skipping transfer tax exclusion amount is irrelevant to the analysis. There is no portability of the generation skipping transfer tax exclusion amount. The American Taxpayer Relief Act of 2013 made the portability provisions permanent, thus reducing much of the uncertainty in this area. V. TIPS FOR FILING THE STATE ESTATE TAX RETURN The Washington State estate tax is an excise tax on the value of estates of Washington residents, or non-residents who owned property in Washington at the time of their death. The tax was enacted in May, 2005. It is codified under CH 83.100 RCW. As it stands, estates of decedents who die on or after May 17, 2005 are subject to the tax; state estate tax rules and forms are specific to the decedent’s date of death. Estate Tax - Deaths on or after May 17, 2005 (http://dor.wa.gov/content/taxes/Other/tax_estateOnAfter051705.aspx).

The Washington State estate tax is independent from the federal estate tax and was not directly affected by the December, 2010 federal legislation.

For deaths occurring on or after January 1, 2006, a return must be filed if the decedent’s gross estate exceeds $2.0 million. The return is to be filed by the personal representative of the decedent; the return is due 9 months after the date of death. A state return is required even if no tax will be due. Practice tip: the Washington state exemption amount will remain fixed at $ 2 million dollars unless the law changes.

The tax is levied against the “Washington taxable estate.” The Washington taxable estate is the federal taxable estate before deducting state estate, inheritance, legacy, or succession taxes, less $2 million for deaths on or after January 1, 2006, and less the amount of real or tangible personal property that qualifies for a farm deduction. If the decedent owns out-of-state assets, the tax due to Washington is prorated based on the ratio of property owned out-of-state. Happily, the estate does not have to actually pay estate tax to another state in order to reduce the tax owed to Washington.

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The following documents are required to be filed with the Washington State Estate and Transfer Tax Return where the date of death occurs on or after May 17, 2005:

• A copy of the federal 706 return, if required • A copy of the death certificate • A certified copy of the will, if one exists • Supporting valuation documentation • Payment, if tax is due In recent years, and as may be once again in the future, the federal and state estate tax exemption amounts may differ. As such, a married couple may be faced with the following dilemma: if on the death of the first spouse the credit shelter trust is funded with property collectively worth the full amount of one or the other of the two exemptions, with the remaining estate payable to the marital deduction portion (whether an outright bequest or a QTIP trust), then a state estate tax or a federal estate tax may be due and payable to either of the tax authorities. In order to avoid that tax, the credit shelter trust could be limited to lesser of the two amounts. The problem with such a plan is that the remaining excess exemption of the first spouse to pass away would be wasted. To assist in alleviating this problem, the Washington State Department of Revenue has provided that the estate of the first spouse to pass away may claim a state-only QTIP election for that portion of a credit shelter trust that exceeds the state-recognized exemption. Thus, the personal representative may choose to make a different QTIP election for Washington Estate and Transfer Tax Return purposes than may be made for federal purposes. The portion of the credit shelter trust subject to the state-only QTIP election would be subject to Washington state estate tax upon the death of the second spouse, but the tax would be deferred until the second death. (Monitor developments regarding state taxation and QTIP trusts funded prior to May 17, 2005.) The differing state and federal estate tax obligations and calculations require an entirely separate state estate tax return, and an entirely new layer of planning considerations, further confounded by the lack of clarity on the current and future status of federal estate tax law. SB 5849 was passed by the Washington State Senate and House in April and signed into law on April 18, 2011 by Governor Gregoire. SB 5849 amends RCW 11.108.090 in response to the federal tax relief, unemployment insurance reauthorization, and job creation act of 2010 (TRA 2010.) Under RCW 11.108.080(1), a will or a trust of a decedent dying after December 31, 2009 and before December 18, 2010, was deemed to refer to the federal estate and generation skipping transfer taxes in effect on December 31, 2009. As of December 31, 2009, the federal applicable exclusion amount was $ 3.5 million. With the enactment of TRA 2010 providing for a federal basic exclusion amount of $ 5 million, a potential ambiguity may be raised when interpreting a will or trust formula clause of a decedent who died in 2010. The issue is whether or not the decedent intended that the $ 3.5 million federal exemption applicable prior to December 18, 2010 applies or the $ 5 million exclusion as codified under TRA 2010 and effective for deaths occurring after December 31, 2009, for trust funding purposes.

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SB 5849 amended RCW 11.108.090 to provide that extrinsic evidence is admissible to the court for the purpose of determining the decedent’s intent under a formula clause contained within a 2010 decedent’s trust or will. The objective is to allow the court to consider evidence regarding the decedent’s intent at the time he or she executed their testamentary documents. The amendment also removes the presumption that the decedent intended that the formula clause should refer to the $ 3.5 million exclusion. The potential ambiguity is significant because the amount funding the credit shelter trust could bestow a windfall on one beneficiary to the detriment of another. For example, consider a married couple, with one spouse having two children by a former marriage. Assume this spouse wished to use his or her federal exclusion amount to pass his separate property of 3.5 million dollars to his children, but bequeath his 1.5 million dollar community property interest in the community property estate of him and his wife in trust for the benefit of his wife, for life. Upon her death, his remaining community interest held under the marital trust is to transfer to his children. If the will is interpreted as bequeathing 3.5 million to the by-pass trust for the benefit of his children – everything transfers in accordance with his intentions. However, if the will is interpreted to bequeath the full federal $ 5 million exclusion to the by-pass trust, the children receive all, the wife receives nothing, and the testator’s intent is defeated. SB 5849 allows the court to take outside testimony on whether or not the decedent intended that the bypass trust be funded with 3.5 or 5 million dollars in assets. The determination may be made pursuant to an action under RCW 11.96A, Washington’s Trust & Estate Dispute Resolution Act, but must be commenced no more than two (2) years following the decedent’s death. SB 5849 also amended RCW 11.86.031 to coordinate the time under which a qualified disclaimer must be made for state estate tax purposes with that of the federal disclaimer time period under TRA 2010, e.g. the earlier of nine months from the date of death or September 17, 2011. SB 5849 provides that the disclaimer must be delivered or mailed by nine months after the latest of:

(a) The date the beneficiary attains the age of twenty-one years; (b) The date of the transfer; (c) The date that the beneficiary is finally ascertained and the beneficiary’s interest is

indefeasibly vested; or (d) December 17, 2010, if the date of the transfer is the date of the death of the creator of the

interest and the creator dies after December 31, 2009, and before December 18, 2010. The provisions of SB 5849 are effective retroactively, to December 31, 2009 and apply only to estates of decedents dying after December 31, 2009 and prior to December 18, 2010. There is no change to the due dates for filing state estate tax returns or to the due dates for payments on estate taxes imposed under Chapter 83.100 RCW. The practitioner must monitor both federal and state estate tax laws going forward because the law is in a constant state of flux.

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VI. TIPS FOR FILING THE FEDERAL GIFT TAX RETURN Although a deceased person cannot make any more inter vivos gifts subject to the federal gift tax, there are a few important post-death gift tax issues to consider. First, the fiduciary should file a gift tax return reporting the decedent’s gifts made in the calendar year of death (and pay any required gift tax) no later than the due date for the estate tax return (or, if earlier, April 15 of the next calendar year). Moreover, the fiduciary should file gift tax returns for any prior years in which taxable gifts were made by the decedent but returns were not filed. Gifts made by either spouse prior to the decedent’s death are eligible for gift splitting. No gift splitting is allowed with respect to gifts made by the surviving spouse after decedent’s death. See Treasury Regulation § 25.2513-1(b)(1). While gift splitting is a nice benefit for the surviving spouse, there can be a trap for the personal representative (if that is not the surviving spouse.) The personal representative is jointly liable for the surviving spouse’s gifts where gift splitting occurs [see § 2513(d)] - there is risk of liability for undisclosed gifts made by the surviving spouse. Finally, the personal representative should consider making a § 645 election before the estate’s first income tax return is due if the decedent had a revocable living trust in effect before death. This election treats the revocable living trust as part of the estate for federal income tax purposes. The election generally lasts for two years. There are several possible benefits from such an election. First, the trust (as part of the estate) could also obtain the benefit of a fiscal year normally reserved for estates. See discussion above about the advantages of a fiscal year. Second, the trust would not be required to pay estimated taxes for the two taxable years following death. Third, the trust would have greater flexibility in holding S corporation stock. Normally, only certain trusts qualify as S corporation shareholders, and those that do not qualify can be shareholders only by agreeing to pay a flat tax at the maximum marginal rate on all items of S corporation income (the so-called “electing small business trust”). Estates, however, may hold S corporation stock for a limited period without having to make any such election and without having to meet any complicated requirements. Fourth, the trust would be allowed to participate in the $600 personal exemption applicable to estates instead of the $300 exemption available to trusts that are required to distribute all income annually. (Trusts other than trusts which distribute all income annually and qualified disability trusts are restricted to a $ 100 personal exemption.) Finally, such an election can consolidate the total number of tax returns and Form K-1s that have to be issued in connection with the decedent’s affairs. Revenue Procedure 98-13 specifies the procedures for making the election on the estate’s federal income tax return. If you make the election, it is helpful to deliver the election forms to the IRS via an IRS approved method for delivery confirmation. See, instructions to Form 1041.

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VII. ITEMS IN RESPECT OF DECEDENT A. INCOME IN RESPECT OF DECEDENT Some income items that are intended to be passed on to heirs of the decedent can be brought back into the estate for estate tax purposes and subject to income tax when received. Specifically, this includes property that constitutes a right to receive an item of “income in respect of a decedent” (“IRD”) under IRC section 691(a). The IRD rules generally apply to items of income which have accrued to a cash basis individual before death but have not actually been received at the time of death. Thus, these items will not have been previously includible in the decedent’s gross income for federal tax purposes. One way to conceptualize the purpose of the IRD rules is that they exist to provide equal tax treatment to both cash and accrual basis taxpayers.

The decedent must have had a right to receive an item of income in order for it to be treated as IRD. The recipient of the IRD item is required to include it in her income tax return for the tax year in which it is actually received. Additionally, the value of the IRD item is includible in the gross estate of the decedent, causing it to be subject to both taxes. As a practice tip, due to the potential high tax liability of IRD items, it is a good idea to advise your clients to donate IRD items to charity, because this will not only produce an estate tax deduction but the IRD item will not be included in the gross income of the taxpayer for income tax purposes.

Common IRD items include salary and fringe benefits accrued at death, fees and

commissions based on services performed during life, an enforceable right to receive amounts under a deferred compensation arrangement, retirement plan payments, dividends declared and payable to a shareholder before death but paid after death, interest owed to the decedent at the time of death, unpaid rental payments on an asset owned by the decedent attributable to the portion of the lease term that expired before her death, the income element of installment sales proceeds, and alimony.

Trusts may receive items of IRD via beneficiary designation or contract made by the decedent, by reason of a specific devise of IRD, or from an estate distribution of IRD. B. DEDUCTIONS IN RESPECT OF A DECEDENT IRC section 691(b) provides that income tax deductions for business expenses, interest, taxes, and depletion that are not properly allowable on the decedent’s last income tax return are allowed on the income tax return of the decedent’s estate in the tax year when they are paid.

There are interesting planning opportunities with deductions in respect of a decedent. These deductions are also allowable to a decedent’s successor-in-interest, though not the estate, if this person has an obligation to pay the expense. As a planning tip, it makes sense to shift these deductions to the taxpayer for whom they will produce the greatest income tax benefit, whether it be the estate or the successor-in-interest. Further, through expenses are generally not permitted to be deducted on both the federal estate tax return and the fiduciary income tax return, this rule does not apply to deductions in respect of a decedent. Finally, if these deductions

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exceed gross income, the administrator should arrange for the deductions to be taken on the final return of the estate, as the excess deductions on the final return will be allocable to the estate beneficiaries when the estate terminates. C. DEDUCTION FOR ESTATE TAX IRC section 691(c) provides an income tax deduction for the estate tax attributable to the inclusion of income in respect of a decedent on the federal estate tax return. This deduction is available to the taxpayer who includes the IRD item in her gross income. This effectively permits a deduction for an amount determined at the highest estate tax rate imposed on the estate. Unfortunately, this deduction is not available for the Washington estate tax.