What Happens When a Person Dies and Owes Taxes?
The passing of a loved one can be an emotionally difficult period. There are also a lot of financial matters that need to be sorted out, including any taxes owed. Which begs the question: Who is responsible for the taxes of a deceased person? What happens to IRS debt when you die? When are they due? And where do the funds come from?
Take the time to learn what’s involved tax-wise after a loved one dies and what to expect.
Who Is Responsible for the Taxes of a Deceased Person?
When someone passes away (which makes them a “decedent”), they may still owe various taxes, including federal taxes like income, estate, and gift taxes, state taxes, property taxes, and corporate taxes if they owned a business. They will usually leave behind assets and property, referred to as the decedent’s estate. Survivors, including a spouse or adult children, may inherit this estate and be responsible for paying these taxes.
“If there is a surviving spouse, he or she could be obligated to pay taxes on behalf of the decedent,” says Agustin Arbulu, a tax attorney and President of the W Tax Group in Southfield, Michigan.
Robert Lyon, an attorney/partner at O’Connor & Lyon, LLP in Durham, Connecticut, explains that if the tax liabilities stem from jointly filed income tax returns with the spouse, the surviving spouse will remain jointly and severally liable for the total amount due.
“That means the IRS can look to collect the balance due from the surviving spouse. The funds can come from that spouse’s separate assets or assets transferred to the spouse by operation of law at the decedent’s death, or from income and assets of the decedent’s estate.”
If there is no surviving spouse, there is usually an executor appointed by the decedent or a probate court to manage the estate. This person would be responsible for negotiating and paying any liabilities, including taxes, left by the decedent from remaining assets and property.
“If a decedent’s estate is not enough to cover all debts, federal income and estate income taxes must be paid first, and state taxes may also come into play,” explains Lyle Solomon, an attorney with Oak View Law Group in Rocklin, California.
How, When, and by Whom Do These Tax Liabilities Get Paid
The process of properly paying the decedent’s taxes first requires initiating probate. This is the legal process that occurs after death that decides how the decedent’s assets will be distributed. Soon after the death, the executor should file a petition to begin probate within the county where the decedent lived at the time of death. If there is no named executor, a survivor of the decedent can file the probate petition and the court will appoint an executor, often referred to as a state administrator.
“The timing for initiating probate and providing to the court the decedent’s will, if one exists, will vary from state to state. The will generally needs to be filed with a court within months of a decedent’s death, and the probate process usually has to be initiated within a few years,” says Lyon.
Assuming the decedent has back taxes that are coming due, it’s important to file for probate sooner versus later.
“In most instances, the tax liabilities of the decedent’s estate will be paid from the estate’s assets, along with other creditors, as part of the probate process. This should occur before any assets are distributed to the decedent’s beneficiaries,” Lyon adds.
Do Survivors Have to Pay Any of These Tax Liabilities Personally?
If there is unpaid tax, the estate’s executor has to repay it with the decedent’s available cash and any proceeds from their liquidated property, per Solomon. This must be completed before any kind of property is transferred.
The good news is that survivors and heirs are usually not obligated to pay the decedent’s tax liabilities from their personal funds.
“If you are the decedent’s child, friend, or extended family, you are not required to pay their taxes or penalties personally. Rather, the funds must come from the estate you have inherited or are responsible for. But suppose you are the decedent’s spouse and have money or assets identified as community property that accrued during the year for which the decedent’s tax return was filed. In that case, you may be obligated to pay the taxes owed,” says Solomon.
For instance, if a husband dies and the wife survives but has also filed a joint tax return with the decedent, she would be responsible for paying the taxes, says Eric Green, an attorney in New Haven, Connecticut.
In fact, Solomon notes that surviving spouses or heirs can be liable for paying a deceased person’s taxes if they:
- Have cosigned a loan with the deceased
- Have a joint bank/financial account with the deceased
- Live in a community property state
- Live in Iowa, Kentucky, Maryland, Nebraska, New Jersey, or Pennsylvania where they must pay inheritance taxes.
“Otherwise, there is no liability on the part of the family to chip in and pay off the decedent’s tax debts,” Green says. “These tax debts will need to be paid from the decedent’s assets.”
But when a decedent’s assets are inadequate to cover their federal income and gift tax liabilities, relatives are not liable for the remaining balances – unless the estate’s executor is a relative.
“The executor of the estate would be the only person who could be held personally liable for the tax bill,” Solomon continues.
But that’s true only if:
- The executor distributes assets to heirs before tax payments are made.
- The executor ends up paying off other estate debts before clearing taxes.
- The executor spends assets even when there are insufficient financial resources to pay the decedent’s taxes.
Examples of Survivor Tax Responsibilities
To illustrate if and when a survivor is on the hook for taxes owed by the decedent, consider the following case in point.
“Say a single mother dies, leaving no will but a sole surviving daughter. The decedent owes income taxes of $16,000 to the IRS and $2,500 in state income taxes,” Arbulu says. “The decedent at the time of her death fully owned a home with no mortgage that had a quick sale value of $48,000. The surviving daughter petitions the probate court, which names her the personal representative of the decedent’s estate. There are no other claims or debts involved.”
Next, the daughter receives the home as the sole heir and ignores paying the federal and state income taxes. In this instance, the daughter would be liable for the unpaid taxes under a “transferee liability” claim for wrongfully receiving property before taking care of the tax obligations.
“In addition, the daughter would also be liable based on a ‘fiduciary liability’ claim, where she had actual or constructive knowledge of these tax obligations before distribution,” he adds.
Let’s tweak that example a bit. Say the same facts apply, except the decedent had a mortgage loan balance of $50,000, recorded with the local registry of deeds and prior to any IRS or state tax liens placed. Consequently, the home is underwater because the decedent owed more on the mortgage than the home was worth at the time of death.
“Then, assume the daughter agrees to buy that home for $50,000. The daughter makes a down payment of $10,000 and secures a $40,000 loan to pay off the underlying mortgage and take title,” Arbulu continues. “In this case, the daughter would not be obligated for the unpaid federal and state income taxes. Of course, I would recommend seeking probate court approval to be on the safe side.”
Why? Because the estate was insolvent, and the transaction was at arm’s length, with the financing by the daughter applied to discharge the underlying mortgage. Hence, nothing is left to pay the taxing authorities, and they would have no choice but release their tax liens. The daughter would not have to pay any of the taxes.
Do Taxes Need to Be Filed for a Deceased Person? If So, Who Files for the Deceased?
The final federal, state, and (if applicable) corporate tax returns of the decedent, for the tax year in which they died, will need to be prepared and filed in the same way as when they were alive.
“However, filing a final income tax return is only required if the decedent’s income exceeds $12,500 in the year of death, in which there were no Social Security benefits received,” notes Arbulu. “If a return is required to be filed, the executor or personal representative of the estate must sign the return and file IRS Form 56 with the IRS as early as possible. If tax returns are not filed as required, the decedent’s estate faces late filing and late payment penalties.”
All income earned up to the date of death must be reported, “as well as all credits and deductions to which the deceased person is entitled,” Solomon notes.
Again, the executor or surviving spouse is usually responsible for paying any outstanding taxes owed by the decedent, as indicated on their tax returns.
Keep in mind that the IRS has up to three years to determine if the correct amount of taxes was paid with the final income tax return.
“To reduce this time, the executor, heir, or surviving spouse should file IRS Form 4810, which is a request to the IRS for a prompt assessment of tax within 18 months,” recommends Arbulu.
What if the IRS Audits the Deceased Person?
Solomon points out that the returns of a deceased individual, like any other tax return, can be audited by the IRS for up to six years after they are submitted.
“The deceased’s tax return can also be audited because the deceased owed taxes, failed to submit documents, or got involved in concealment or fraud when filing,” Solomon adds.
Note that a person’s death will typically not stop an IRS examination that is underway at the time of death.
What Happens if There Is No Estate After Death?
Suppose the decedent owes taxes and does not have an estate to be probated. In that case, collection agents will likely do an initial investigation into whether or not there are any assets in the estate.
“The IRS will need to determine, with reasonable certainty, that there are no assets with available equity in the estate. They will also need to determine that no estate assets were transferred to the beneficiaries or junior creditors instead of paying the decedent’s tax liability,” Lyon explains. “If so, they are likely to place the delinquent account into a "currently not collectible" status. That means the tax balances will be written off following a 10-year collection statute.”
In a nutshell, if the estate does not have sufficient funds to cover the taxes owed, these tax obligations will go unpaid without penalty to the heirs or survivors, according to Arbulu.
“And if the decedent didn’t have any reportable income or assets to claim at the time of death, no tax returns need to be filed, either,” he says.