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When Can Estate Assets Be Distributed?

When Can Estate Assets Be Distributed
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Many estate executors focus on estate taxes and forget about income taxes. That can be an expensive mistake.

Just as an individual pays taxes, so do estates. An estate must file an annual income tax return for each calendar year it is open, even if only for part of the year. In addition to the estate tax return and the decedent’s final tax return must be filed, explains a recent article, “The Dangers Of Distributing Estate Assets Too Soon” from Forbes.

The estate tax return is based on the assets in the estate, the income received and deductible expenses paid during the calendar year. Only one estate tax return is required. However, as long as the estate is open, an annual estate income tax return needs to be filed.

Many executors distribute income to beneficiaries shortly after it comes into the estate to minimize income. The estate takes a deduction for the income distributed to beneficiaries in the same year it is received by the estate. Beneficiaries are required to include the distribution in their gross income.

However, if the estate does not distribute income before the end of the year, the estate will owe income taxes. There are further complexities to be aware of, including what happens if an executor receives unexpected income or does not know the tax impact of certain transactions. The estate has to pay taxes, but what happens if all assets have been distributed?

The estate still owes those taxes.

The executor may be personally liable for paying the taxes.

If some of the expenses the estate pays are not deductible, but the executor thinks they are, then the estate will have an income tax liability, possibly without the cash to pay it.

The estate often receives property taxable as income if not distributed to beneficiaries, like a stock dividend. The estate gets the stock and its taxable income based on the value at the distribution date.

If the estate does not distribute the stock to beneficiaries until later in the year and the stock’s value declines, the estate is still required to recognize the income equal to the stock’s value on the date the estate received it. If the executor deducts the lower value of the stock, then the estate will be liable for the income tax on the difference.

In some cases, the executor can prevent these issues by maintaining a certain level of cash in the estate account until the final estate tax return is filed. The beneficiaries receive distributions once all taxes—estate income, estate, and final individual or joint—are paid.

For larger or more complex estates, it is wise to have a tax discussion with the estate planning attorney, the family CPA, and the executor, so all parties are prepared for tax liabilities in advance.

Reference: Forbes (Feb. 16, 2022) “The Dangers Of Distributing Estate Assets Too Soon”