When an executor or other fiduciary is compensated for their work, it is considered taxable income. As such, there are specific requirements related to reporting this income on his or her taxes.
The income received as compensation as a fiduciary or executor goes under the heading “other income” on Line 21 on Form 1040. For example, if you earned $20,000 as an executor, you fill in $20,000 on Line 21 by the line named “Other Income.”
Typically, this income is not subject to self-employment tax. An exception is if the executor ran a business that was part of the estate. Another exception is if the executor or fiduciary routinely handles estates. Therefore, if serving as an executor was a one-time occurrence and you were not actively participating in a business owned by the estate, you are most likely not subject to self-employment tax.
Importance of Self-Employment Tax Information
It is critical to know whether you will be classified as self-employed. This is because being self-employed carries a larger tax burden. When you work directly for an employer, your employer is usually responsible for withholding the proper amount of federal taxes, state taxes and potentially local taxes. Additionally, an employer withholds taxes for Social Security and Medicare, known as the FICA tax. If an employee indicated the proper amount of deductions and the employer withhold the proper amount of taxes, the employee usually will not owe taxes when filing his or her annual tax return.
In addition to transferring the employee’s FICA taxes to the government, the employer is also responsible for paying an equal rate for the employee. In 2016, the employee and employer rate was 7.65 percent, making a total of 15.3 percent paid to the government. This rate is applied up to a certain max income as established by law.
When an individual is self-employed, he or she does not have an employer who is making the 7.65 percent contribution. Additionally, no one is withholding taxes on behalf of the individual. Therefore, the employee is usually required to make quarterly estimated payments for applicable federal, state and local taxes. Additionally, the employee is responsible for the entire 15.3 percent for FICA taxes. However, the self-employed individual can deduct 7.65 percent of the self-employment tax by including the deduction on Line 27 of Form 1040 on the line named “One-half of self-employment tax.”
If the executor received $20,000 in pay and was taxed at a federal tax rate of 20 percent, his or her tax liability on this amount would be $4,000. However, if the executor’s income was considered self-employment income, the individual would still have the initial tax liability of $4,000 from the income. He or she would also have an additional $2,800 of tax due to the self-employment tax.
Sometimes an executor may receive a notice from the Internal Revenue Service that states that he or she owes an additional amount of tax, such as $2,800. This is because the IRS may mistakenly believe that the executor’s income was from operating a business because the income is listed under “Other Income.” The executor’s first action may be to call the phone number listed on the IRS notice and explain to the representative the source of the income. He or she may explain that the income was from acting as an executor and that he or she was not actively participating in a business and is not in the routine business of serving as an executor. The representative may ask for the executor to provide evidence of the source of income. Such evidence may be from documentation from the probate court or from cancelled checks that indicate payment to the executor from the estate.
If this notice arrives years after the executor’s work has been performed, he or she may no longer have personal documentation that establishes the source of income. However, he or she can ask the probate court for documentation in its records that show the source of income. When the executor submits this evidence, he or she may also state that he or she is not subject to self-employment tax.
Do You Need to File a Tax Return for the Estate?
The executor must file a federal income tax return (Form 1041) if the estate has:
What kind of income does an estate have? Common examples are rents from real estate in the estate, salary that wasn’t paid to the deceased person before death, or interest on an estate bank account.
If you promptly distribute all the estate assets to the people who inherit them, the estate may not have income, and you may not need to file an income tax return for it. For example, if the deceased person owned a house in joint tenancy with his spouse, and had payable-on-death designations on his bank accounts, those assets will pass immediately to their new owners at death. They won’t generate income for the estate.
Form 1041: The Estate’s Income Tax Return
The income tax return form for estates is IRS Form 1041. It’s also called a “fiduciary” return, because you file it in your capacity as executor of the estate. (An executor is a fiduciary—that is, someone who is entrusted with someone else’s money and has a legal duty to act honestly and in the best interests of the estate.) The Form 1041 return is similar to the personal income tax return, Form 1040, that we all file every April 15. There’s a “Decedent’s estate” box at the top the form, which you should check. The executor of the estate is responsible for filing a Form 1041 for the estate. The return is filed under the name and taxpayer identification number (TIN) of the estate. On it, you’ll report estate income, gains, and losses, and will claim deductions for the estate. You don’t have to include a copy of the will when you file the return.
The Estate’s Tax Year
The estate’s tax year begins on the date on which the deceased person died. You, as executor, can file the estate’s first income tax return (which may well be its last) at any time up to 12 months after the death. The tax period must end on the last day of a month. If you file in any month except December, the estate has what’s called a fiscal tax year instead of a calendar tax year.
All estates get a $600 exemption. You can also deduct:
Forms for Beneficiaries
If you distribute income to beneficiaries, they are responsible for paying income tax on it. When you file the estate’s Form 1041, you must give each beneficiary a Schedule K-1 form, showing how much the beneficiary received during the tax year.
Paying the Tax
The executor is responsible for making sure that the estate pays any income tax due. The tax is paid from estate assets.
The executor of a will has a fiduciary duty to act in the best interest of the estate. This means that the law prevents you from acting in your own interest to the detriment of the estate. As an extension of this duty, executors also have several responsibilities to the beneficiaries of the will. The most notable responsibilities among these are the notification of inheritance and timely management of the estate. If you have estate planning questions, consider speaking with a financial advisor.
Notification and Right to Information
An executor’s biggest responsibility to beneficiaries is to notify them that they are, in fact, beneficiaries. Beneficiaries have the right to know they’ve been included in a will early on in the probate process. That way, they have a chance to contest anything they have an issue with.
Different states and counties have different requirements regarding the method of giving notice. To be safe, it’s a good idea to send beneficiaries a document stating their place in the will. This way, each beneficiary will have the notice in writing, and there can be no ambiguity that you’ve delivered the notice.
In addition to formal notification, the beneficiary also has a right to information about the estate and the probate process. This includes what assets are in the estate, how much debt the estate has and how the executor plans to pay that debt.
This doesn’t necessarily mean you need to provide beneficiaries with detailed balance sheets or dollar amounts down to the cent. You may not even have that information until you finish doing inventory on the estate. This means is that if beneficiaries have questions about what’s in the estate, or your plan to pay off any debts, you owe them an answer. As executor, it’s a good idea to keep everyone abreast of the process as it proceeds.
Another responsibility the executor has is to distribute assets to the beneficiaries in a timely manner. Different states have different interpretations on what constitutes “a timely manner.” Some states don’t put any time frame in writing, while others stipulate one year as the deadline.
This isn’t to rush an executor such that he or she doesn’t do a thorough job. It’s in place to prevent any executors from filing the will in probate court and then doing nothing and letting the estate just sit in limbo. Additionally, there are a handful of expenses that come with the probate process, including taxes. So it’s in everyone’s best interests to distribute assets in a timely manner to avoid losing money to these expenses.
What an Executor Doesn’t Have to Do
While an executor is obligated to notify beneficiaries and then move things along at a reasonable pace, he or she isn’t required to distribute inheritances at the time of notification. In fact, beneficiaries might not receive anything until several months after they’ve been notified of their place in the will. Before assets can go to their heirs, for instance, the executor will need to settle any of the estate’s debts. Because creditors need time to make claims against the estate, this can last for a bit. Executors are also under no obligation to include beneficiaries in the decision-making process. While it’s a good idea to keep beneficiaries up to date on the process, executors have authority from the court to make decisions about how to manage the estate.
What Happens If the Executor Is a Beneficiary?
It’s actually quite a common occurrence that an estate’s executor is also one of its beneficiaries in some capacity. For instance, you might be the executor of your grandfather’s estate, as well as the heir to his house. Most people want to fully trust their named executor, making family and close friends obvious choices. Should this arrangement come up in your situation, there really isn’t anything to specifically worry about. In fact, many court systems are in favor of beneficiaries also being executors. In short, you can begin the process of probate and estate management as per usual regardless of whether the executor is a beneficiary or not.