Effective estate administration means identifying, valuing and collecting assets, filing tax returns, making distributions and determining cash needs to pay taxes, expenses and debts, among many other tasks.

This is where the executor and trustee enter the picture.

Tax decisions made by these fiduciaries during administration are dependent on specific deadlines following the decedent’s date of death. These decisions need to balance the estate, gift, income and generation-skipping transfer tax consequences against a range of non-tax consequences. This often means assessing the needs of the estate’s individual beneficiaries and the practicalities of the estate administration process.

Tax considerations after the death of a spouse: A case study

The following story of the death of the husband in a high-net-worth family illustrates how decisions behind elections can be evaluated for the most successful outcome for the estate and the beneficiaries.

A husband, 83, dies on October 24, 2023, leaving a surviving spouse, 80, and three adult children in their 50s. Both the husband and wife were New York state residents. The husband lived in assisted living for several years and, despite having long-term care insurance, incurred significant out-of-pocket medical expenses.

The husband’s estate plan stipulated that assets would be collected into an administrative trust for the duration of the administration, and then fund a Credit Shelter Trust with assets valued at the husband’s New York state estate tax exemption ($6.58 million for 2023), with the balance of the assets funding a Marital Trust for the benefit of the wife. When the wife passes, any remaining assets in both the Credit Shelter Trust and the Marital Trust will fund continuing trusts for each of the couple’s children.

The couple’s balance sheet is as follows:

• Marital residence owned jointly as tenants by the entirety; valued at $2.5 million.
• Adirondack cabin owned jointly as tenants by the entirety; valued at $500,000.
• Investment account titled in husband’s sole name; valued at $20 million.
• Investment account titled in wife’s sole name; valued at $5 million.
• Tangible property all titled in husband’s sole name; valued at $2 million.
• No credit card debt.
• A small mortgage on the primary residence.
• Medical expenses.

After the husband’s death, several tax returns will need to be filed. When and how these are filed can make a difference in how taxes are calculated for the estate as a whole:

• 2023 Final Personal Income Tax Returns: Federal Form 1040 and New York State Form IT-201 – Due April 15, 2024. Since the death occurred during 2023, the husband’s personal income tax returns (reporting income earned from January 2023 through death in October 2023) need to be prepared and filed by April 15, 2024, subject to a six-month extension of time to file (due by October 15, 2024).
  
• Fiduciary Income Tax Returns: Federal Form 1041 and New York State Form IT-205 – Due date for these returns is dependent on the year end. Estates and trusts are separate taxpayers for income tax purposes. The estate and the Administrative Trust will need Employer Identification Numbers (EINs) and fiduciary income tax returns need to be prepared, annually, for each entity, beginning with the date of death and continuing through termination of the estate and the Administrative Trust.
  
• Note that many clients do not obtain a separate EIN when they create and fund a revocable trust, because the grantor trust income rules permit the income earned on the assets owned by the revocable trust to be reported on the decedent’s personal income tax return under his or her Social Security number. However, upon death, the revocable trust becomes irrevocable and must obtain its own EIN. Even if a separate EIN for the revocable trust had been obtained, the fiduciaries will still need to obtain a new EIN for the now irrevocable Administrative Trust.
  
• Estate Tax Returns: Federal Form 706 and New York State Form ET-706 – Due July 24, 2024. Given that the husband’s assets exceed both the 2023 New York State estate tax exemption ($6.58 million) and the 2023 federal estate tax exemption ($12.92 million), federal and New York State Estate Tax returns need to be filed. The returns are due nine months after his death (or July 24, 2024), subject to a six-month extension of time to file, and report an inventory of his assets as of his date of death, as well as any permissible deductions, such as estate administration expenses and debts.
  
• Other returns may be due. Fiduciaries must take care to ensure that other tax returns, such as gift tax returns, unfiled personal income tax returns or business returns, are all filed and current. Fiduciaries are personally obligated in this regard.
  

Maximizing Savings Opportunities through Tax Elections

There are hundreds of elections and decisions to be made during estate administration. We’ll use the above scenario to review our thinking around key tax-filing decisions.

JULIE: Brian, given the facts of this matter, how would you approach the final personal income tax return?

BRIAN: One of the first decisions that the fiduciaries face is whether to file the husband’s final personal income tax return as a joint return with his wife. Under our scenario, the wife has not remarried during the tax year, which ends on December 31, 2023 [see IRC section 6013(a)(2)], and neither spouse is a nonresident alien [IRC section 6013(a)(1)]. Therefore, we can file the final income tax return as a joint return. The joint return would include the husband’s income and deductions through his date of death, and wife’s income and deductions for the entire taxable year. [See Treasury Regulations section 1.6013-1(d)(1).]

JULIE: What is the benefit of filing the husband’s final personal income tax return as a joint return?

ELISA: The fiduciaries should consider filing a joint return if the husband’s deductions exceed his income. This preserves his deductions, assuming the wife has enough income for the year to offset the deductions; moreover, it avoids wasting the husband’s excess capital losses and excess charitable deductions if the wife has, or can generate, capital gains or other income in the husband’s final tax year. This can be especially advantageous when the decedent dies early in the year and thus has not earned significant income or incurred capital gains.

Another advantage of filing a joint return is that the husband’s income is subject to more favorable tax rates when married filing jointly. If a joint return is not filed, they will each need to file under the married filing separately status for 2023, resulting in less favorable tax rates. [See IRC section 1(a) and (d)].

JULIE: Are there any disadvantages or risks to filing jointly?

BRIAN: One disadvantage is that liability for the entire tax is joint and several for the surviving spouse and the fiduciaries, per IRC section 6013(d)(3), so there may be a risk of assuming the wife’s unknown tax liabilities. In this scenario, they were married for many years, and we also worked with them for more than 20 years, so we were comfortable with filing the final income tax returns jointly.

JULIE: How should medical expenses be treated on the return?

ELISA: Given that the husband was ill for several years prior to death and incurred significant out-of-pocket medical expenses, another important decision is whether to deduct his unpaid medical expenses as of date of death on the jointly filed final personal income tax returns or on the estate tax returns, per IRC section 213(c) and 2053(a)(2).

The expenses may be deducted on either the personal income tax returns or estate tax returns, but not both. The ability to deduct medical expenses on the income tax returns is subject to limitations. A decedent’s unpaid medical expenses can never be deducted on the estate’s fiduciary income tax return.

JULIE: How do you decide whether to take the deductions on the personal income tax returns or on the estate tax returns?

ELISA: If the medical expense was paid during the one-year period after the husband’s death, the expense will be deemed paid by him at the time it was incurred, and thus eligible to be deducted on the final personal returns [IRC section 213(c)(1)]. But a statement must be included with the returns stating that the amount has not been taken as a deduction on the federal estate tax return and waiving the right to have the amount deemed a deduction on the federal estate tax return at any time [IRC section 213(c)(2)].

Most importantly, the medical expenses may only be deducted on the final personal income tax return if the total of the unreimbursed expenses exceeds 7.5% of the adjusted gross income (AGI) reported on the return, per IRC section 213(a). If they do not, the decision is simple: the expenses should be reported on the federal estate tax return; if they do, it’s still important to calculate the impact of deducting the expenses on the final personal income tax returns, versus on the estate tax returns to determine which method will result in the lower overall tax paid by the estate.

In our scenario, the medical expenses did not exceed 7.5% of his adjusted gross income for the year, so the medical expense deduction was only permitted for the estate tax returns. However, even in instances where the unreimbursed medical expenses exceed 7.5% of AGI there may be little or no tax benefit to the taxpayer. That is because only the amount that exceeds 7.5% of AGI is deductible and must be further evaluated with the other Schedule A itemized deductions to see if the taxpayer will benefit from itemizing deductions or taking the standard deduction on the tax return.

JULIE: What are the strategic elections available for the fiduciary income tax returns?

BRIAN: Arguably the most important election an executor will make with respect to the estate’s fiduciary income tax return is choosing the tax year of the estate. At the husband’s death, his estate and Administrative Trust become separate taxpayers, with all income and deductions on assets owned by the estate and Administrative Trust reported on fiduciary income tax returns.

Interestingly, unlike most individuals and trusts, estates are not required to report income and deductions on a calendar-year basis and can elect instead to report on a fiscal-year basis, although an executor is not obligated to select a fiscal year and can select a calendar year. The tax-year election is made on the estate’s first fiduciary income tax return. The estate’s first tax year can be less than one year and must end on the last day of the month, per IRC sections 443(a) and 441(e).

The primary objectives of the tax-year selection include:

• equalize the income tax brackets of the estate and beneficiaries
• defer payment of income taxes
• use the estate’s $600 exemption from income tax and separate taxpayer status [IRC section 642(b)(1)]
• satisfy the immediate financial needs of the beneficiaries
  

Before the election is made, the executor should project the timing of anticipated income and allowable deductions and then prepare projected income tax returns with different tax years to see the impact of selecting one fiscal year over another. The executor should also consider the needs of the estate’s beneficiaries when choosing a tax year.

JULIE: What is your analysis of the tax year selection in this case?

BRIAN: The executors can choose the longest tax year. In other words, the first tax year for the husband’s estate would end on September 30, 2024, and report all income earned from date of death through September 30. The fiduciary income tax returns are due 3.5 months after the end of the estate’s tax year, or January 15, 2025. By choosing the longest fiscal year, it is possible to defer payment of income tax; however, a shorter fiscal year is possible as well. Essentially, projected income tax returns should be prepared to determine whether a shorter or longer initial fiscal year makes the most sense.

JULIE: How are taxes handled for the Administrative Trust?

BRIAN: The estate and the Administrative Trust are separate taxpayers for fiduciary income tax purposes. Technically, the estate would file one income tax return, reporting any income and deductions for assets owned by the husband in his individual name prior to his death.

The Administrative Trust, on the other hand, would report post-death income and deductions for assets owned by the revocable trust prior to his death. Trusts are not permitted to file fiduciary income tax returns on a calendar year like estates can. However, the IRS allows a special election under IRC section 645 to be made to treat the “qualified revocable trust” as part of the estate for income tax purposes. This election is made by completing and filing IRS Form 8855 by the due date of the estate’s first fiduciary income tax return, including extensions [IRS section 645(c)]. This election is irrevocable once made under IRS section 645(c).

Practically speaking, this means that the fiduciaries can make this election and then report all the Administrative Trust’s income on the estate’s fiduciary income tax return. This eliminates the need to file two separate income tax returns and allows the Administrative Trust to report its income on the same fiscal year as the Estate.

JULIE: It seems like the 645 election is critical to consider when you have a pour-over plan.

BRIAN: Yes, the 645 election streamlines the filings and allows the Administrative Trust to file on a fiscal year. In this case, the fiduciaries can make a 645 election and report all income earned by the estate and Administrative Trust on a single fiduciary income tax filing each year. Assuming the longest fiscal year is chosen, the first combined estate and Administrative Trust fiduciary income tax return will be due January 15, 2025, and will report income earned through September 2024. In subsequent years, the combined fiduciary income tax returns will report income earned from October 1 through September 30, and will be filed the following January 15, 3.5 months after the close of the fiscal year, subject to a 5.5-month extension.

Given that estates and Administrative Trusts are essentially conduits for ordinary income tax purposes, distributions made from the estate and/or Administrative Trust during the first fiscal year to the Credit Shelter and/or Marital Trusts will carry out Distributable Net Income to these trusts, which they will report on their fiduciary income tax returns, which must be filed on a calendar year. Therefore, income earned by the estate and Administrative Trust during calendar year 2023 may not be reported to the Credit Shelter and/or Marital Trusts until calendar year 2024, allowing a deferral of income tax payable.

JULIE: Are there any other special considerations when making a 645 election?

ELISA: The first consideration relates to the charitable set-aside deduction afforded to estates [see IRC section 642(c)]. In simple terms, if the estate’s income is set aside for a charitable beneficiary during any tax year, even if the income is not actually distributed to the charity, the estate is entitled to a charitable income tax deduction on its fiduciary income tax return. The idea is that estate administration is complicated, and the fiduciaries may not be able to distribute the income but should not be penalized for not being able to do so. Note that this charitable set-aside is only available to estates, not trusts; therefore, if the charitable bequest is made within the Administrative Trust as opposed to the will, the trust will not be permitted the charitable set-aside deduction. However, if a 645 election is made, the Administrative Trust, now reporting its income on the estate’s fiduciary income tax return, is entitled to the charitable set-aside deduction. Therefore, if you have charitable bequests in an Administrative Trust, it is critical that you make the 645 election.

Second, the 645 election is only effective for two years from the date of decedent’s death if no federal estate tax return is required. If a federal estate tax return is required, the deadline is six months after the final determination of estate tax liability [IRC section 645(b)(2)].

JULIE: Let’s discuss the estate tax returns.  What decisions need to be made on those returns?

ELISA: Estate taxes are a concern for larger estates. The federal and New York State Estate Tax Returns are due for the husband’s estate nine months after his death [IRC section 6075(a)], subject to a six-month extension to file for both returns [see Treasury Regulations section 20.6081-1(c)]. Assuming the extension is requested, the returns would be due on January 24, 2025.

But one key point is that this is only an extension of time to file the returns, not an extension of time to pay any tax due [see IRC sections 6075(a) and 6151(a)].  Under the husband’s plan, there will be no tax due, as the plan was designed to maximize the New York state estate tax exemption by funding a Credit Shelter Trust with the available New York state exemption amount. Also, a Qualified Terminable Interest Property (QTIP) election can be made on the assets funding the wife’s Marital Trust to make those assets eligible for the unlimited marital deduction, which provides for a deferral of federal estate taxes on those assets until the wife’s passing [see IRC section 2056(b)(7)].

JULIE: How does the QTIP election work?

ELISA: The QTIP election is a powerful tool that permits the husband to provide for the wife during her remaining lifetime, but still control the disposition of the assets funding the Marital Trust at her death. The assets in the Marital Trust will pass in further trust for the couple’s three children and their issue at the wife’s death. Had the husband’s plan provided for the assets to pass outright to the wife instead of to a Marital Trust, she would have sole control over those assets and could revise her estate plan after the husband’s death to bequeath the assets to someone other than the couple’s children. If the assets passed outright to the wife, they would automatically qualify for the marital deduction. However, the Marital Trust can qualify for the QTIP election so long as the wife is the only beneficiary of the trust during her life, and she receives mandatory distributions of net income from the assets during her lifetime. (She can also receive mandatory or discretionary principal distributions, but this is not required to qualify for the QTIP election.) [IRC section 2056(7)(B)].

The QTIP election is made on Schedule M of the Federal Form 706 and allows the assets passing to the trust to qualify for the unlimited marital deduction, even though they are not passing outright to the wife [see Treasury Regulations section 20.2056(b)-7(b)(4)(i)]. As mentioned, this results in an estate tax deferral, as the assets remaining in the Marital Trust at the wife’s subsequent death will be includable in her gross estate for federal and New York state estate tax purposes, valued as of her date of death [see IRC section 2044(b)(1)(A)].

JULIE: How does Portability factor here?

BRIAN: Portability is a federal estate tax concept only; it does not apply to New York state. The general concept is that any unused federal estate tax exemption remaining at the husband’s death can be “ported” over to the wife for use by her fiduciaries at her subsequent death [see Treasury Regulations section 20.2010-2]. In this case, the fiduciaries are using $6.58 million of the husband’s $12.92 million federal estate tax exemption by funding the Credit Shelter Trust with the New York state estate tax exemption amount. By then making a QTIP election for the remaining assets that are funding the Marital Trust, the fiduciaries are not utilizing the husband’s remaining federal estate tax exemption and would be wasting $6.34 million (difference between $12.92 million and $6.58 million) of the husband’s remaining federal estate tax exemption if they did nothing with it. However, the fiduciaries can avoid this waste by making a Portability Election on the husband’s Federal Estate Tax Return (Form 706) in order to preserve this remaining unused exemption—called the Deceased Spouse’s Unused Exclusion (DSUE)—for use by the wife’s fiduciaries at her subsequent death.

Brian Conboy is Director of Estate Administration at Fiduciary Trust Company International.

Elisa Pickel is Senior Estate Settlement Officer at Fiduciary Trust Company International.

Julie Min Chayet is Managing Director at Fiduciary Trust Company International.

The authors wish to thank Michael M. Mariani, Esq., retired Deputy General Trust Counsel of Fiduciary Trust Company International, who developed the initial Post-Mortem Estate Planning outline and program, as well as Kenneth Kito, Wealth Director at Fiduciary Trust Company International, who contributed to this article.