Tax Issues and Returns

Executors of wills, administrators of decedents’ estates, and trustees of trusts are considered fiduciaries because they hold money or other assets on behalf of beneficiaries. The fiduciary must file federal and state income taxes reporting income and capital gains earned by the estate or trust.

The personal representative of the decedent must file the final income tax return (Federal Form 1040 and Pennsylvania Form 40) of the decedent for the year of death and any returns not filed for preceding years. The final income tax return is due at the same time the decedent’s return would have been due had death not occurred. The decedent’s income includible on the final return is generally determined as if the person were still alive except that the taxable period is usually shorter because it ends on the date of death. The method of accounting regularly used by the decedent before death also determines the income includible on the final return.

Pennsylvania has an inheritance tax that is an excise tax on the receipt of inherited property by a beneficiary. The rates of tax depend on relationship to the decedent. Property passing to a spouse or to a charity are not taxed. For property passing to lineal descendants, mother, father, grandmother, grandfather, wife or widow of a child, husband or widower of a child, the rate is 4.5 percent. Lineal descendants include children and more remote descendants. Children includes stepchildren and adopted children. For property passing to siblings of the decedent, the rate is 12 percent. For property passing to anyone else, the rate is 15 percent. The tax must be paid within nine months of the decedent’s death. If the tax is paid within three months of the date of death, there is a 5 percent discount available for early payment.

The Federal Estate Tax is imposed by the federal government on the transfer of property from person to another at death. Estates are required to file a federal estate tax return if the value of the “gross estate” (i.e. the total estate before deductions) is above a certain dollar amount adjusted annually for inflation (for 2015, the amount is $5.43 million). The gross estate includes the value of all property in which the decedent had an interest at the time of his or her death, including such items as real estate, stocks and bonds, mortgages, notes and cash, insurance on the decedent’s life and jointly owned property.

The generation-skipping transfer tax is a tax imposed on both outright gifts and transfers in trust to or for the benefit of unrelated persons who are more than 37.5 years younger than the donor or to or for the benefit of related persons more than one generation younger than the donor, such as grandchildren.

The gift tax is a tax on the gratuitous transfer of property from one person to another made during the donor’s lifetime. Certain gifts are exempt from the gift tax. These include: (i) present interest gifts valued at a maximum dollar amount of $14,000 (in 2015) (or $28,000 if gift splitting between spouses is elected) to any one individual in a single calendar year; (ii) gifts to a spouse; (iii) payment of tuition or medical expenses on behalf of someone else; (iv) charitable contributions; and (v) certain gifts to political organizations.

Partnership taxation is the taxation of a partnership business entity. Partnerships are a flow-through entities where the taxes are assessed at the entity level but which are applied to the partners of the partnership. Flow-through taxation means that the entity does not pay taxes on its income. Instead, the owners of the entity pay tax on their “distributive share” of the entity’s taxable income, even if no funds are distributed by the partnership to the owners. Federal tax law permits the owners of the entity to agree how the income of the entity will be allocated among them, but requires that this allocation reflect the economic reality of their business arrangement, as tested under complicated rules.

An opinion letter is an attorney’s written tax advice about the treatment or consequence of a transaction. Clients seek these letters because they want to predict how the IRS and the courts will treat a transaction. In certain cases, clients are even required by law to obtain an opinion letter.