The Final Tax: Understanding Taxes After Death
- Phoenix S. Ayotte, Esq.
- Feb 7
- 4 min read
Updated: Mar 12
Dealing with the legal and financial ramifications after the passing of a loved one can be complex. One critical area is understanding the taxes associated with death, such as estate tax and inheritance tax. At Future Counsel, estate planning is one of our core practice areas. This blog post offers an overview of the types of taxes that may be due, providing valuable legal insights to navigate this challenging time and protect your assets.
Types of Taxes After Death
1. Final Income Taxes (Form 1040)
What It Is: The deceased person’s income taxes for the year they passed away, covering income earned up until their death.
How It Works:
If someone passes away in June 2025, you would file a personal income tax return for the first six months of 2025 by April 15, 2026.
If the person was married, the surviving spouse may file a joint return, including their own income for the entire year and the deceased’s income up to the date of death.
Who Pays the Taxes:
Any owed taxes are paid from the estate. If there’s a refund, it’s issued to the estate for distribution to beneficiaries.
What Happens if the Estate Can’t Pay:
If the estate lacks sufficient funds, the executor can petition the court to declare it insolvent. Beneficiaries are generally not responsible for the deceased’s personal tax debts unless they co-signed loans or held joint assets.
2. Income Taxes on the Estate (Form 1041)
What It Is: If the estate continues to earn income after death (e.g., rental income, dividends, or interest), this income is taxable and reported on IRS Form 1041.
Threshold for Filing:
Filing is required only if the estate earns more than $600 in a year.
Taxable Income Includes:
Rent from properties owned by the estate.
Interest earned on estate bank accounts.
Dividends from estate-held investments.
Key Deductions:
Administrative costs (e.g., legal fees, executor compensation).
Distributions to beneficiaries.
Taxpayer Identification Number (TIN):
The estate needs its own TIN to keep financial matters separate from the executor or beneficiaries.
3. Taxes on Inheritance
General Rule: Inheritances themselves are not taxable, but income earned from inherited assets may be taxable.
Examples:
Interest: If you inherit a bank account, the money already in it isn’t taxed, but interest earned after inheritance is taxable.
Retirement Accounts: Withdrawals from inherited 401(k)s or IRAs are generally taxed as ordinary income.
Life Insurance Proceeds:
Lump-sum payouts are tax-free.
If paid in installments, any interest earned on those installments is taxable.
4. Capital Gains Taxes
What It Is: Tax on the profit made from selling an inherited asset for more than its "date of death value."
How It Works:
When someone passes away, their property gets a "step-up in basis" to its fair market value on the date of death.
Example:
Your parent bought a house 40 years ago for $100,000, but at the time of their death, it was worth $400,000. If you sell it for $450,000, you only owe capital gains tax on the $50,000 profit, not the $350,000 appreciation over 40 years.
Exemptions:
If you sell the inherited home quickly and at its date-of-death value, there’s typically no taxable gain.
5. Estate Taxes
Federal Estate Taxes:
Only applies to estates worth more than $13.99 million (as of 2025; this limit adjusts annually for inflation).
Taxes are paid by the estate before distributions to beneficiaries.
State Estate Taxes:
Imposed by 12 states and Washington, D.C., with thresholds ranging from $1 million to $5.74 million.
Beneficiary Liability:
In rare cases, if assets bypass probate (e.g., through trusts or payable-on-death accounts) and the estate can’t pay its tax bill, beneficiaries might be required to cover the remaining estate taxes.
6. State Inheritance Taxes
States With Inheritance Taxes: Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania.
When It Applies:
Usually only applies to non-immediate family members (e.g., distant relatives, friends).
Small inheritances and inheritances passed to spouses or close family members are often exempt.
Practical Tips for Executors and Beneficiaries
Understanding Executor Responsibilities
Executors are legally responsible for filing the deceased’s final taxes and any taxes owed by the estate.
If taxes are misfiled, the executor may be held personally liable, even if they hired a tax professional.
Keeping detailed records and seeking professional advice can mitigate risks.
When to Seek Professional Guidance
Simplifying Tax Filing
Key Takeaways
Most Inheritances Are Tax-Free: The majority of beneficiaries won’t owe taxes on what they inherit.
Taxable Income from Assets: Be mindful of income generated by inherited assets, such as interest, dividends, rent, or gains from selling property.
Planning Helps Avoid Surprises: Working with legal and tax professionals ensures compliance with federal and state laws while protecting beneficiaries and the estate.
By understanding these rules and seeking the right support, you can navigate the tax implications of an inheritance or estate administration confidently.
Need Expert Assistance?
Dealing with the financial aftermath of a loved one's passing is difficult. Let Phoenix S. Ayotte, Esq. of Future Counsel help you understand the complexities of taxes after death. We provide compassionate and knowledgeable guidance to Virginia, Maryland, or Washington, D.C. (DMV) clients.