Dave Frees:      Number nine has to do with failure to promptly and timely file Pennsylvania inheritance tax and federal estate tax return and the Pennsylvania and Federal income tax returns for the decedent and for the estate.  Let me go over that again, because if that sounds like a lot of returns, you’re right.  When someone passes away, you’ll almost always have to file a final lifetime income tax return for them for Pennsylvania and for the Feds.  And even though a lot of advisors say don’t do it if they didn’t make much money, I like to do it, I like the client to do it, the executor to do it because it then removes that deceased taxpayer from the tax rolls. 


The IRS knows that they’ve passed away and they’ve been informed of that and they take them off the tax rolls, so that things don’t crop up later causing trouble.  So, first of all you have to file these and they’re due by April 15th, so for example, if you’re an executor, and the decedent passed away anytime in 2005, that 2005 return is due by April 15, coming right up so you want to get on that.  From the time the decedent passes away till the end of that tax year, you also will probably have what is called a fiduciary income tax return. 


You’re going to have to file a return reporting the income of what the estate earned. So if the estate earned interest on the bank accounts, and the estate earned dividend income or the estate earned rent, the estate now has to file an income tax return for that.  Typically, we encourage the same CPA or tax preparer who’s preparing the decedent’s final income tax return to also prepare these 1041’s. Now, encourage people out there to be careful, I don’t want to mention any tax preparing service by name or anything, but there’s a lot of services out there that do a great job out there for people for a modest price in preparing the 1040, that’s the income tax return, but they’re not very good, they’re not very used to, and they’re not well equipped for filing the 1041, which is the income tax return for the trust or the estate.  Very different set of issues there. So you want to make sure whoever you hire knows how to and can do both kind of returns, and that’s usually the accounting firm. 


Also, within 9 months of death, you must file both a Pennsylvania inheritance tax return and in some cases a Federal estate tax return.  And these returns, they look relatively simple, but they have a lot of strategic issues and you have to make certain elections and they have to be made on a timely filed return or you could get into trouble again. Also when I file returns with the state and federal government, I like to attach everything I can think of.  When I file returns, they’re in great big binders, all tabbed with all the evidence of valuation and the reason for this is, we want the taxing authorities when that examiner looks at them and they’re trying to decide to whether audit your return or not, we’re going to say look at this. They have given me everything and they have explained I’m not going to get rich or famous in the IRS by spending a lot of time working on this tax return. In all the years I’ve been doing on this, I will knock on wood here, I think I’ve had two audits, and both of them resulted in no change, which is good , that means that even after the Internal Revenue Service went through these federal estate tax returns, they accepted them as they were filed, which is the desired result. 


So, it’s important to file these in a timely way, to have them prepared professionally, to have professional preparers that really know what they’re doing about valuation because they can save you, they know the red flags, they know the things to avoid, they know the documentation that needs to be attached and again, that should be money that is extremely well spent.  And the money that’s spent to prepare those returns is deductible again.  So, timely filing these returns in a very thorough and professional way giving the taxing authority all the information to back up the particular positions that you’ve taken. 


And people may be wondering what do you mean by that Dave, well there are various elections that can be made on these returns, for example, on the federal return you can file using the date of death values, or what’s called the alternate valuation date values, you need to document them in a certain way.  When you have E-bonds and you redeem them, you can report that income on the estate’s income tax return or on the decedent’s final income tax return, and where they go is a strategic decision based on how much income tax is going to be paid, you’re going to try to lower the liability there. Whether you should take an executor’s commission or not, in many cases it doesn’t make sense to, because if you take an executor’s commission, you’re going to have to pay income tax on it at much higher rate, but in cases where there’s a big federal estate tax liability at 42% rate, even if you’re paying a 35% tax, you’re saving that difference. 


So these are all things where, again, if you’ve got a smart preparer, who’s strategically helping to prepare these, you may end up spending a lot less time, you may end up not having an audit, you may end up generating tax savings that significantly offset their fees or make their fees disappear.  So filing these returns, failing to file them timely, failing to file them, filing them in a messy way, filing them without the appropriate documentation, these are all mistakes that come under nine, and that are very common and that can be very, very costly.  And again, if you incur penalties as a result of that, you’re personally liable again, not the estate, but you the executor could be charged for these additional penalties and expenses.

David M. Frees III Esq.


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David M. Frees, III
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Attorney, Speaker and Author