TAXPLANNER
If a decedent had an interest in a passive activity (e.g., a partnership or S corporation), the passive activity will be treated as though the activity was sold at death, triggering the recognition of any suspended losses on the decedent’s final individual tax return. However, these losses may have to be reduced depending on whether the interest received a step-up in basis. Generally, the remaining suspended losses may not be transferred to the partner’s successor in interest. You should consult with your tax advisor for more information.
S corporation income. If the decedent was a shareholder in an S corporation, include on the final return the decedent’s share of the S corporation’s items of income, loss, deduction, and credit for the following periods:
- The corporation’s tax year that ended within or with the decedent’s final tax year (the year ending on the date of death); and
- The period, if any, from the end of the corporation’s tax year in (1) above to the decedent’s date of death.
Example. Julia was a 20% partner in XYZ Partnership and a 20% shareholder in ABC Corporation, an S corporation. The tax year for both the partnership and the corporation ends on December 31. Julia died on October 1, 2017. Had she lived, Julia would have earned $100,000 of ordinary income in 2017 from the partnership and another $100,000 of ordinary income from the corporation.
Julia’s final tax return for 2017 will include $75,070 (274 days) of income from ABC Corporation and $75,070 of income from XYZ Partnership. The remaining $24,930 of ABC Corporation income and the $24,930 from XYZ Partnership income will be included in the tax return of the successor in interest.
Self-employment income. Include self-employment income actually or constructively received or accrued, depending on the decedent’s accounting method. For self-employment tax purposes only, the decedent’s self-employment income will include the decedent’s distributive share of a partnership’s income or loss through the end of the month in which death occurred. For this purpose, the partnership income or loss is considered to be earned ratably over the partnership’s tax year. For more information on how to compute self-employment income, see chapter 39, Self-employment income: How to file Schedule C.
Coverdell Education Savings Account (ESA). Generally, the balance in a Coverdell ESA must be distributed within 30 days after the individual for whom the account was established reaches age 30 or dies, whichever is earlier. The treatment of the Coverdell ESA at the death of an individual under age 30 depends on who acquires the interest in the account. If the decedent’s estate acquires the interest, the earnings on the account must be included on the final income tax return of the decedent. If a beneficiary acquires the interest, see the discussion under Income in Respect of a Decedent, later.
The age 30 limit does not apply if the individual for whom the account was established, or the beneficiary that acquires the account, is an individual with special needs. This includes an individual who because of a physical, mental, or emotional condition (including a learning disability) requires additional time to complete his or her education.
For more information on Coverdell ESAs, see Publication 970, Tax Benefits for Education.
Archer MSA. The treatment of an Archer MSA, a Medicare Advantage MSA, or a Health Savings Account (HSA) at the death of the account holder depends on who acquires the interest in the account. If the decedent’s estate acquires the interest, the fair market value of the assets in the account on the date of death is included in income on the decedent’s final return.
If a beneficiary acquires the interest, see the discussion under Income in Respect of a Decedent, later. For more information on Archer MSAs, see Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans.
Exemptions, Deductions, and Credits
Generally, the rules for exemptions, deductions, and credits allowed to an individual also apply to the decedent’s final income tax return. Show on the final return deductible items the decedent paid (or accrued, if the decedent reported deductions on an accrual method) before death.
Exemptions. You can claim the decedent’s personal exemption on the final income tax return. If the decedent was another person’s dependent (for example, a parent’s), you cannot claim the personal exemption on the decedent’s final return.
Standard deduction. If you do not itemize deductions on the final return, the full amount of the appropriate standard deduction is allowed regardless of the date of death. For information on the appropriate standard deduction, see chapter 21, Standard deduction.
Itemized deductions. If the total of the decedent’s itemized deductions is more than the decedent’s standard deduction, the federal income tax will generally be less if you claim itemized deductions on the final return. See chapters 22 through 29 for the types of expenses that are allowed as itemized deductions.
Medical expenses. Medical expenses paid before death by the decedent are deductible, subject to limits, on the final income tax return if deductions are itemized. This includes expenses for the decedent as well as for the decedent’s spouse and dependents.
For information on certain medical expenses that were not paid before death, see Decedent in chapter 22, Medical and dental expenses.
3 Armed Forces Tax Guide