Uncomfortable Tax Topics - What You Should Know

It is often stated that the two guarantees in life are death and taxes. While commercials for planning for “final arrangements” are common on the airways, it is not a topic we like to think about, and quite honestly, not something we like to bring up in our tax discussions. However, recognizing the tax implications and taking appropriate steps can significantly impact the tax burden that is ultimately faced by loved ones. This applied both in terms of taxes to be paid and the administrative burden of completing the necessary tax filings.

While we strongly encourage all our clients to have a long-term estate plan, this article focuses on unexpected situations. Having a trusted family member to assist can be helpful with navigating the financial issues while dealing with the emotional stress of a loss.

·       Minnesota credit for stillborn child

Minnesota offers parents of a stillborn child a refundable credit of $2,000 if the tax year that the stillbirth was experienced. To qualify, you must have a Certificate of Birth Resulting in Stillbirth from the Minnesota Department of Health. You must also have been eligible to claim the child as a dependent in the year the stillbirth occurred. Just provide this information to your tax professional when bringing in your documents so that they can make sure the credit is claimed. You can also submit an amended return up to three years after the filing deadline to claim this credit.

·       Dependent claim for a child who dies after birth

A child who was or born or died during the year (but not stillborn) can still be claimed as a dependent or as a qualifying child for the Earned Income Credit during the year that they were born or died. The child is treated as living in the home more than half the year if they were in the home (or temporarily absent from the home) for more than half the time they were alive during the year.

·       Domestic abuse victims

New for 2024, an exception was added to the 10% early withdrawal penalty from qualified retirement plans and IRAs for domestic abuse victims. Domestic abuse victims can take an early distribution of up to $10,000 during a period of 1 year beginning on any date of abuse without incurring the 10% penalty (note that the distribution will still be taxable). Domestic abuse victims should see if their plan offers distributions for this reason. If not, the exemption can still be claimed on their tax return.

·       Death of a spouse

After the death of a spouse, we generally recommend that you meet with your estate attorney as early as possible to go over your rights and obligations with regard to your spouse’s assets and liabilities. Having your tax professional either attend this meeting or be given permission to communicate with your attorney can streamline the tax planning process. A couple examples of things to be aware of are

 1) In the year a spouse dies, the surviving spouse will still file a return as Married Filing Jointly. The following year he or she will file as single if the surviving spouse doesn’t have any qualifying dependents. If the surviving spouse does have qualifying dependents, they are eligible for the Qualified Surviving Spouse status for an additional two years as long as they do not remarry in the time. Planning for the change in tax rates can potentially result in significant savings over the long term;

2) the tax basis of any assets owned by the deceased spouse are “stepped up” to their fair value at time of death. For jointly owned assets, the step up applies to the deceased spouses share. Your tax professional can provide guidance to make sure the basis step up is properly documented. This can result in substantial savings in capital gains taxes for investments and other assets if sold in the future.

Every person’s situation is unique and working with the appropriate professionals to make sure all issues are identified and addressed property can help ease the emotional as well as the financial burden.

·       Death of a family member

We have had many clients and friends that unexpectedly found themselves responsible for handling the estate of a parent, sibling, aunt, or uncle. If this happens to you, you do need to find a good estate attorney as early as possible. But proceed with caution. If you have flexibility, interviewing prospective attorneys to make sure you understand their process and fee structure is important. We do not necessarily recommend picking the lowest cost attorney but selecting the one that seems to be the best fit for you to work with. We have a friend that was name executor of his brother’s estate. He shared with us he felt like the attorneys took control of the process and pretty much set their own fees, leaving him feeling like he was more on the sideline.

Identifying all bank and investment accounts as early as possible is important. Working with your attorney, you will most likely want to obtain a tax ID number for the decedent’s estate (or trust if applicable) and transfer the ownership of the accounts. If there are any retirement accounts (such as IRAs, 401k, or annuities), a tax advisor can work with you to identify the tax consequences of the liquidation or distribution of these accounts.

Engaging a tax professional early in the process is important to ensure you understand the tax filing obligations and determine if there are any planning opportunities to minimize the taxes paid by the estate and / or the heirs.

·       Terminal Illness

In the unfortunate event of a terminal illness diagnosis, there may be some moves that can be made to reduce the tax burden on you and your heirs. There are also potential common missteps can result in unnecessary tax obligations. Because everyone’s situation is unique, we are not attempting to discuss specific issues in this article. Meeting with a tax professional while you are able can be very beneficial to minimize both the financial and administrative burden for your loved ones. 

If any of these situations apply to you, please call us for an appointment. We will be happy to sit down and go over your situation with you. As stated, every person’s circumstances are unique. This content is informational only and does not constitute tax, legal or professional advice. While best efforts are made to ensure all information is accurate at the time of posting, tax laws and guidance from regulatory agencies are subject to change.