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Income Tax Actions by Executors on Behalf of Decedents
By Sidney Kess
New York Law Journal
May 21, 2001
An executor is responsible for filing income tax returns on behalf of a decedent. The executor generally steps into the shoes of the decedent, having all the same tax election opportunities that the decedent had prior to death. But in some cases, actions by an executor may be limited.
Filing Tax Returns
When a taxpayer dies, an executor must file income returns on the decedent's behalf. If the decedent dies before filing the return for the prior year (for example, the executor dies in January 2002 before filing the 2001 return), then the executor must file Form 1040 income tax returns for both the year of death and the prior year on behalf of the decedent. If the decedent dies after filing the prior-year return, then the executor must file an income tax return on the decedent's behalf for the year of death. Income tax returns following the year of death are returns of the decedent's estate - Form 1041.
When the decedent is married at the time of death, a spouse can file a joint return unless the executor objects. As a practical matter, in most cases, the surviving spouse is the executor and so there would not be any objection. Furthermore, even if the surviving spouse is not the executor, filing a joint return generally is preferable to filing a final return, as married filing separately so again, there would not be any objection to filing a joint return.
An executor has the right for up to one year to revoke the filing of a joint return made by a surviving spouse before the executor's appointment. However, revoking the joint return and filing a separate return is viewed as a late-filed return, resulting in interest and penalties, plus any additional taxes that may be due because of the change in filing status.
Medical expenses. An executor who pays the decedent's medical expenses within one year of death can claim them as an itemized deduction on the decedent's final income tax return (subject to the 7.5 percent floor). This is so even though it is the executor and not the decedent who paid the bills. However, the executor must attach a statement to the income tax return waiving the right to deduct the same medical expenses on the estate tax return.
When a decedent is not subject to estate tax - his estate is fully shielded by the exemption amount ($675,000 in 2001) and/or the marital deduction - then the waiver is advisable to allow the deduction on the income tax return. But where the decedent has a taxable estate, it generally makes more sense to claim the deduction for estate tax purposes - the deduction may save as much as 45 cents on every dollar of medical costs (if the estate is in the 55 percent tax bracket) and there is no 7.5 percent floor for estate tax purposes.
Claiming a Home Sale Exclusion
A homeowner can exclude gain on the sale of a personal residence up to $250,000 ($500,000 on a joint return). The only requirement: The home must have been owned and used as a principal residence for at least two out of five years preceding the date of sale.
Can an executor who sells a home after a homeowner's death claim the exclusion? The answer would appear to be yes.
Under the old home sale exclusion, the IRS had ruled that an executor could claim the exclusion where the decedent had entered into an executory contract for a sale prior to his death (Rev. Rul. 82-1, 1982-1 CB 26). This would seem to still be a valid rule.
According to one example in proposed regulations on the home sale exclusion, an executor can join with a surviving spouse to claim the $500,000 exclusion on a joint return (Prop. Reg. §1.121-b(3), Example 4). A couple had owned and used their home as their principal residence since 1998. The husband died on Feb. 16, 2001. The wife sold the home on Sept. 21, 2001, realizing a gain of $350,000. Where the executor files a joint return with the surviving spouse for 2001, all of the gain is excluded (the $500,000 exclusion limit applies).
Claiming Innocent Spouse Relief
Spouses generally are jointly and severally liable for the taxes on a joint return. But one spouse may escape liability with respect to items and actions of the other spouse by making a claim for innocent spouse relief (Code §6015). At present, it is unclear whether an executor can initiate this claim on behalf of a decedent.
Recently a couple died and the IRS made adjustments to their joint returns from earlier years. The wife's executor filed Form 8857, Request for Innocent Spouse Relief, seeking innocent spouse relief with respect to those years on the grounds that the wife was unaware of the husband's partnership investments that gave rise to tax liability. The IRS ruled that the executor could not assert an innocent spouse claim - only a spouse can (FSA 200117005). The IRS noted that if the spouse had initiated the claim prior to her death, then the executor could have pursued it.
This ruling is in contrast to a recent Tax Court decision allowing a successor-in-interest to raise an innocent spouse claim (Hale Exemption Trust, TC Memo 2001-89). This case involved a couple that divorced in 1981. Thereafter the IRS questioned their 1979 and 1980 returns. During this process the husband died and the wife made a claim for innocent spouse relief. The trustee of the husband's estate, as successor-in-interest to the husband, objected to the wife's claim. The Tax Court held that where a nonelecting spouse has died, his or her successor-in-interest - for example, a trustee or an executor - can initiate or participate in (or in this case object to) a claim for innocent spouse relief. It remains to be seen how the Tax Court's view and the IRS's view on this question will be reconciled.
Sidney Kess, CPA-attorney, is a consulting editor to CCH Inc., an author and a lecturer.