What you need to know about tax as an estate executor
It's hard enough dealing with the loss of a loved one without having to confront the burdens of administering their estate. However, for thousands of Aussies, this is exactly the situation they find themselves in as the executor of a loved one's Will.
It's an experience that there can't be any training for, and many find themselves totally out of their depth.
One of the hardest things an executor must do is to finalise the deceased's tax position so here's my guide to getting your loved one's income tax situation finalised.
Notifying the ATO that a person has died
The first step following the death of a person is to let the ATO know that the death has occurred.
In the first instance, if you are the legal personal representative (LPR), executor, court appointed administrator or next of kin you can unofficially notify the ATO of the death by calling 13 28 61. This will stop the ATO sending correspondence to the deceased.
Next, you'll need to provide the ATO with official notification of the death by completing the form Notification of a deceased person (NAT 74279). You can complete the form online or by post.
If you lodge online, you'll need to provide a contact phone number and attend an interview at an Australia Post outlet, taking the original death certificate (or a certified copy) with you. If you complete and post the paper form, you'll need to include a certified copy of the death certificate.
You can also use this form to advise the ATO that you are the executor or administrator of the estate by providing either the original or a certified copy of any one of the deceased's will, a letter of administration or evidence of grant of probate.
You'll also need to inform the deceased person's super fund of the death and ask them to release the super. If you don't know the super account details for the deceased, you can use the Check Your Super facility on the ATO website.
Lodging a final tax return for the deceased
The next step in the process is likely to be to lodge a final tax return for the deceased.
This will cover the period from July 1 at the start of the tax year of death through to the actual date of death and will include all income earned by the deceased up to the date of death, including employment income, bank interest, dividends, etc.
In most respects, it is a normal tax return, with normal individual tax rates applying (including the Medicare levy and Medicare levy surcharge) and a full tax-free threshold available (even where the death occurred part way through the year).
The words "Deceased Estate" should be printed on the top of page one of the tax return, and the executor signs it on behalf of the deceased.
Apply for a Tax File Number for the deceased estate
The deceased estate will need a different TFN to the deceased person. It will be the executor's job to obtain one. This will be required if the deceased estate is likely to have to lodge a tax return in its own right, for example if it will have taxable income from investments.
A TFN can be obtained by completing and lodging the form Tax file number - application for a deceased estate (NAT 3236) or through your tax agent.
Prepare and lodge trust tax returns for the deceased estate
The deceased estate tax return includes only income received after the deceased has passed away. It is separate to the date of death tax return.
In many cases, the executor will have to complete two tax returns in one year.
The first will be the final tax return for the deceased, covering the period up to the date of death.
The second will be the first tax return for the deceased estate, covering the period from the date of death to 30 June. In both cases, the full tax-free threshold can be claimed, which means that the deceased gets two tax-free thresholds in one year.
In some cases, a deceased estate may be wrapped up quite quickly, meaning that only one or two deceased estate returns may need to be lodged.
In other cases, it can take many years to administer an estate and a deceased estate tax return can be an ongoing commitment for the executor. A trust tax return for the deceased estate will need to be lodged every year until the estate stops earning income as its various assets and liabilities are settled.
Any income earned by the estate after the date of death must be reported in the deceased estate return, including:
- salary and wages paid by an employer after the date of death
- bank interest
- eligible termination payments
- dividends
- rent from investment properties, and
- capital gains from the sale of assets.
Expenses incurred in earning that income can be deducted.
Some are of the type that any taxpayer might report (such as costs of running a rental property) but others are more specific to a deceased estate such as professional fees (including tax and legal help) incurred by the executor in administering the estate. Funeral expenses are not tax deductible.
Tax losses
If the deceased has brought forward losses accumulated in earlier years, these can be used to offset income in the final, date-of-death tax return for the deceased but they cannot be carried forward and used by the deceased estate.
If the deceased becomes aware that death is likely and has accumulated capital losses, it can be worthwhile gifting assets to beneficiaries before death.
The transfer will be at market value (since the two parties are not acting at arms-length) which will trigger a capital gain to the transferor. This capital gain can be absorbed by the brought forward capital losses.
The advantage of this strategy over simply allowing the asset to pass to the same beneficiary under the will on death is that, even though the transfer on death won't trigger a capital gain, the gift while alive will uplift the cost base of the asset to the beneficiary. The beneficiary will then face a smaller capital gain when they ultimately dispose of the asset.
HECS-HELP debts
If the deceased had an outstanding student loan under HECS or HELP, a repayment may be required based on the income of the deceased recorded in the final, date-of-death tax return.
That repayment will need to be made from the deceased estate. From that point on however, the debt is cancelled. No further repayments need be made in relation to post-death income from the estate.
How is income of the deceased estate taxed?
Income earned by the deceased estate is taxable either to:
- the beneficiaries, or
- the executor
Whether it is the beneficiary or the executor that is liable for tax will depend on whether the beneficiary is either presently entitled to income from the deceased estate or under a legal disability.
To be presently entitled to income means that the beneficiary has an unchallengeable right to that income and can demand immediate payment.
To be under a legal disability means that the beneficiary is either under 18 at the end of the tax year, bankrupt or legally incapable (for instance because of a mental illness).
Broadly speaking, in the early phase of the administration of the estate, the beneficiaries will not be presently entitled to income from the estate since there will still be debts to be paid and the possibility that the Will may be challenged from some quarter. As such, the tax liability will rest with the executor.
For the first three years of the administration of a deceased estate, the executor will be taxed at normal individual tax rates, with a full tax-free threshold. No Medicare levy is payable.
From the fourth year onwards, special tax rates apply (no Medicare is payable):
As the administration of the estate progresses, it becomes increasingly likely that the beneficiaries will be presently entitled to income, meaning that the beneficiary then becomes liable for tax on the income they are entitled to (even if it isn't actually paid to them).
The beneficiary must declare the distribution of income from the deceased estate in their personal tax return and will pay tax at their normal rate.
Where they become entitled to income in one year but don't actually receive a payment until a later year, the income is taxed in the earlier year.
If the beneficiary is presently entitled to income but is under a legal disability, the executor (not the beneficiary) is responsible for the tax on that income, payable at normal individual tax rates (not the higher rates listed above) plus Medicare levy.
If income is paid to someone under 18, special rates normally apply but where the income is from a deceased estate, the income is taxed at normal individual rates plus Medicare levy.
Where a beneficiary is non-resident, the executor of the deceased estate is liable for the tax on that beneficiary's share of the income of the estate, payable at non-resident rates. No Medicare levy is charged.
Interest and unfranked dividends are not included in a non-resident beneficiary's income; instead a final withholding tax (which is charged at different rates for different countries) is payable to the ATO by the executor. Withholding tax is not applied to fully franked dividends.
The executor will receive a separate notice of assessment from the ATO in relation to each beneficiary who is either under a legal disability or non-resident.
Where a franked dividend is paid to a resident beneficiary, the associated franking credits flow through from the deceased estate to the receiving beneficiary.
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