Inside the Black Box: Executors’ Elections

Theresa McGinley, JD, Kevin Duncan, JD, and Brian Conboy, JD
Published Date:
Jan 1, 2020

During the administration of a decedent’s estate, an executor performs four basic functions: identifies and collects the decedent’s assets; determines cash needs for payment of expenses and debts, and raises cash to pay the expenses; files any required tax returns, including the decedent’s final personal income tax returns, gift tax returns, estate tax returns, and fiduciary income tax returns, and pays associated taxes; and distributes assets in accordance with the terms of the decedent’s Last Will and Testament.

In completing these tasks, the executor is faced with various elections and decisions that must be made within a specific time period after the decedent’s date of death. In determining whether to make an election, the executor should balance the estate, gift, income, and generation-skipping transfer tax consequences of each election with the non-tax consequences, such as the needs of the individual beneficiaries of the estate.

This article will focus on some of the more common elections the executor must make on the decedent’s final personal income tax return, the estate’s income tax return, and the federal estate tax return.

Joint Final Personal Income Tax Return with Surviving Spouse

One of the first decisions that an executor faces is whether to file the decedent’s final personal income tax return, which reports the decedent’s income from the beginning of the taxable year of death (generally January 1) through the decedent’s date of death, as a joint return with the surviving spouse. [See Treasury Regulations section 1.443-1(a)(2).]

A joint return may only be filed if the decedent was married to the surviving spouse on the date of death and the surviving spouse has not remarried before the end of the taxable year in which the decedent passed away, per IRC section 6013(a)(2). Note that a joint return cannot be filed if either spouse is a nonresident alien at any time during the taxable year, according to IRC section 6013(a)(1). Assuming these requirements are met, the joint return includes the decedent’s income and deductions through his or her date of death, and the surviving spouse’s income and deductions for the entire taxable year. [See Treasury Regulations section1.6013-1(d)(1).]

The executor should consider filing a joint return if the decedent’s deductions exceed income in order to avoid the loss of excess deductions in the decedent’s final tax year, assuming the surviving spouse has enough income to offset the deductions.  Moreover, the executor can avoid wasting the decedent’s excess capital losses and excess charitable deductions if the surviving spouse has or can generate capital gains or other income in the decedent’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 decedent’s income is subject to more favorable tax rates when married filing jointly. If a joint return is not filed, the decedent and surviving spouse will each need to file under the married filing separately status, resulting in less favorable tax rates.

Despite the many advantages of filing a joint return with the surviving spouse, one disadvantage is that liability for the entire tax is joint and several for the surviving spouse and the executor [(IRC section 6013(d)(3)]. The executor should consider whether they are willing to assume risk for the surviving spouse’s unknown tax liabilities.

Medical Expense Deduction

Another important decision facing an executor is whether to deduct the decedent’s unpaid medical expenses as of date of death on the decedent’s final personal income tax return or on the federal estate tax return, per IRC section 213(c) and 2053(a)(3). The expenses may be deducted on one return, but not both, and the ability to deduct is subject to the below limitations. Note that the decedent’s unpaid medical expenses can never be deducted on the estate’s income tax return.

If the executor pays the medical expense during the one-year period after the decedent’s death, the expense will be deemed paid by the decedent at the time it was incurred, and thus is eligible to be deducted on the final personal return [IRC section 213(c)(1)]. However, in order to be able to deduct the expense on the final personal return, the executor must include a statement attached to the final personal return 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)].  

Moreover, the medical expenses may only be deducted on the final personal income tax return if the total of the expenses exceeds 10% of the adjusted gross income 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. Otherwise it is important to calculate the impact of deducting the expenses on the final personal income tax return versus on the estate tax return in order to determine which method will result in the lower overall tax paid by the estate.

Selection of Estate’s Tax Year

Once an individual dies, the individual’s estate becomes a separate taxpayer, with all income and deductions to be reported on a fiduciary income tax return. 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. 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, according to Treasury Regulations section 1.441-1(c)(1). The estate’s first tax year can be less than one year and must end on the last day of the month, per IRC section 443(a) and 441(e).

The primary objectives of the tax-year selection are to—

  • 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, and
  • 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 needs of the estate’s beneficiaries should also be considered when choosing a tax year.

Qualified Revocable Trusts

An important election related to the selection of the estate’s tax year is the ability of an executor to treat the decedent’s revocable trust as part of the decedent’s estate for federal income tax purposes. This election is more relevant today than ever, with so many individuals creating and funding revocable trusts as part of their routine estate planning. The election permits revocable trusts to take advantage of special rules that are typically only available to estates. 

For example, the election permits the income and deductions of the estate and revocable trust to be reported on a single income tax return, thereby allowing the revocable trust to report its income and deductions on a fiscal year instead of a calendar year. Moreover, the revocable trust will be allowed to take advantage of a regulation permitting estates a charitable deduction for amounts permanently set aside for charitable purposes, without requiring that such amount actually be paid in order to secure a charitable deduction [see IRC section 642(c)].

The 645 election must be made by both the executor of the estate and trustee of the revocable trust [IRC section 645(a)] and is made by completing and attaching IRS Form 8855 to the estate’s first income tax return, including any extensions [IRC section 645(c)]. The election is irrevocable once made under IRC section 645(c).

A word of caution: the election is only effective for two years from the date of decedent’s death, if no federal estate tax return is required, or if a federal estate tax return is required, six months after the final determination of estate tax liability [IRC section 645(b)(2)]. In the event that the administration lasts beyond the expiration of the 645 election, the trustee of the revocable trust will need to obtain a new taxpayer identification number for the trust and report its income and deductions on a separate fiduciary income tax return, which must be on a calendar year. See Treasury Regulations section 1.645-1(h)(1) and Treasury Regulations section 1.645-1(h)(4).

Administration Expenses

Administration expenses can be taken as deductions on the federal estate tax return and as deductions on the estate’s fiduciary income tax return. Generally, administration expenses can be deducted on either the federal estate tax return or the fiduciary income tax return, but not both. Double deductions are not permitted under IRC section 642(g). There are, however, some notable exceptions to this rule (i.e., funeral expenses are only permitted as deductions on the federal estate tax return and not on the fiduciary income tax return, and the decedent’s debts are similarly only permitted as deductions on the federal estate tax return and not on the fiduciary income tax return). This rule also does not apply to deductions for taxes, interest, business expenses, and other items accrued at decedent’s death; these “deductions in respect of a decedent” are deductible for estate tax purposes under IRC section 2053(a)(3) and for income tax purposes under IRC section 691(b).

Examples of typical estate administration expenses include executors’ commissions; fees of professionals retained by the executors, such as attorneys, accountants, and appraisers; and real estate brokerage commissions and auction commissions in connection with selling real estate and tangible property, respectively. Other expenses include the costs of storing, insuring, and securing estate property.  

The starting point for analyzing whether to deduct these expenses on the federal estate tax return or on the fiduciary income tax return is a comparison of the estate’s estate tax bracket with its income tax bracket, and the effect the election will have upon the beneficiaries of the estate. It may also be most beneficial to divide the deduction between the two tax returns, for example, by deducting $20,000 of legal fees on the estate’s first income tax return and deducting all remaining legal fees on the federal estate tax return. 

Note that the Tax Cuts and Jobs Act of 2017 suspended the miscellaneous itemized deduction, which may prevent estates from deducting some administration expenses on the estate’s income tax returns; however, IRS Notice 2018-61 confirms that expenses incurred in connection with the administration of the estate or trust and which would not have been incurred if the property were not held by such estate or trust remain deductible on the estate’s income tax returns; therefore, most deductions available to an estate prior to the enactment of the Tax Cuts and Jobs Act remain available.

Further Considerations

This article only scratches the surface of the elections and decisions that an executor must make during the administration of an estate. Many of the elections require detailed analysis, with the executor weighing the impact of the election on the estate, its beneficiaries, and any taxes that may be owed by the estate and the beneficiaries. In determining whether to make an election, the executor should consult with legal and accounting professionals to ensure they are making an informed decision.

Theresa McGinley, JD, Managing Director, Trust Counsel and National Head of Trust Administration, is a senior trusts and estates advisor with over 15 years of experience in estate planning and trust administration including tax planning, preparation of estate tax returns, settlement agreements, reporting and valuation. She also serves as Trust Counsel, providing guidance on complex trust and estate arrangements including estate planning, gifting techniques and charitable strategies. She serves on Fiduciary Trust’s Management and Operating committees. Prior to joining Fiduciary Trust, Theresa was an associate at Katten Muchin Rosenman, LLP and was previously associated with Schlesinger Gannon & Lazetera, LLP. She has been a speaker for the New York State Bar Association (NYSBA), the NYU Tax Conference and Committee of Banking Institutions on Taxation and has contributed to the NYSBA’s publications. She received her Juris Doctor degree from St. John’s University School of Law and her Bachelor of Arts degree, magna cum laude, from University of Scranton. Theresa is currently a member of the New York State Bar Association and serves on its Estate and Trust Administration Committee and a member of the New York City Bar formerly serving on its Estate & Gift Taxation Committee and its Trusts, Estates & Surrogates Court Committee. She is admitted to the Bars of New York, New Jersey and Florida.

Kevin J. Duncan, JD, Managing Director, Director of Estate Administration and Trust Counsel, manages and develops all aspects of estate administration, leading a team of experienced estate specialists across the firm. As Trust Counsel, Kevin provides guidance on all aspects of estate planning. Prior to joining Fiduciary Trust, Kevin worked in the wealth advisory group of Lazard Wealth Management, advising clients on various tax and estate planning opportunities to meet their financial and personal goals. He earned a Masters in Tax Law, with distinction, from Georgetown University, a Juris Doctor degree, cum laude, from Western New England University, and a BBA from the University of Miami. He is a member of the Massachusetts Bar.

Brian D. Conboy, JD, Managing Director, Senior Estate Settlement Officer, is responsible for the administration of complex trusts and estates at Fiduciary Trust.  Previously, Brian was an associate attorney at the law firm of Eisenberg, Margolis & Maldonado, PLLC, in Garden City, New York, where his primary practice areas were estate administration and estate planning. He earned his Bachelor of Arts degree, magna cum laude, in economics and Spanish, from Bucknell University and his Juris Doctor degree from Hofstra Law School.  He is a member of the New York State Bar.

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