When you pass away, the executor of your estate is tasked with paying a variety of expenses, fees, and other financial obligations on your behalf. These are called estate tax deductions and can often be overlooked.
These deductions will typically include any funeral expenses, debts and loans that you owed at your date of death, and any costs incurred to administer the assets of your estate. This process can be a bit of a headache if the financial affairs are not adequately organized.
These expenses are generally deductible on your estate tax return and will reduce the value of your estate. Suppose you do not owe any estate tax at your death. In that case, many of these expenses can then be taken as tax deductions on the estate tax return and used to reduce your beneficiary’s tax liability. But whoever is the executor of your estate must understand these rules and hire knowledgeable professionals to obtain any tax savings.
Several items, including expenses and losses, are allowed as deductions against the gross estate. In this post, we look at some of the basic deductions that can be used to reduce your estate. Some of these are very basic, but some are often missed by the executor and tax and legal professionals.
But first, let’s consider that these deductions will come in five general categories. We will define each category and then look at the specific expenses in each category. Here are the categories:
- Special deductions (marital and charitable)
- Administration expenses
- Funeral expenses
- Mortgages and debts
Table of contents
Special deductions
1) Marital Deduction
Probably the most crucial deduction for married couples is the Marital Deduction. When a married person has property that is included in the gross estate, it will pass directly to the surviving spouse under the marital deduction. As a result, the estate tax will not be paid until the death of the surviving spouse.
2) Charitable Donations
Charitable donations can be deducted from the gross estate. But they work a little differently compared to deductions for income tax purposes. First, the estate tax charitable deduction allows gifts or donations to foreign charitable organizations. However, the income tax charitable deduction is only allowed for charitable donations made to U.S. charities.
The estate tax donation deduction is unlimited. So in theory, an estate would be able to gift away the entire gross estate and not have any estate tax liability.
Administration expenses
Accounting and tax return fees
These costs typically include CPA review and consultation, tax fees to prepare the final tax return, estate and trust federal and state filings, if applicable.
Legal fees
This includes any attorney fees, filing costs, and probate costs necessary to administer your property and affairs.
Executor or trustee fees
An executor or trustee can receive compensation for services performed to the estate.
Appraisal fees
This includes appraisal costs for the valuation of assets as of the date of death.
Funeral costs
Examples of this include funeral and cemetery plot expenses and payment to clergy who officiate the funeral. A tombstone, monument, flowers, and burial lot costs should also be considered.
Asset expenditures
Costs that are incurred to maintain your assets in fair condition before the final distribution to your beneficiaries.
Selling or asset distribution costs
There are often costs or fees associated with the disposition of your estate assets.
Claims or assessments
These are amounts you owed at your death that your estate has a legal obligation to pay.
Housing-related costs
Final utility bills, insurance, HOA fees, real estate taxes, maintenance costs for the month in which you pass away should be considered.
Mortgages and debts
Mortgages
Any mortgage liability on real estate you own at your death also qualifies for an estate tax deduction. For example, if you die with a $250,000 mortgage loan on your primary residence, this can be deducted on your estate tax return.
The outstanding mortgages or other debts secured by the individual’s property will offset the property’s value included in the estate.
Credit card bills
Any credit card obligations at the date of death will generally be obligations of your estate.
Tax liability on final tax return
Any income tax obligation on your final tax return.
Interest accruals
Interest that is accrued on mortgages, credit cards, or other debts up to the date of the individual’s death.
Medical expenses
Medical expenses paid are also an estate deduction. In addition, if those expenses are paid within one year of your death, they can be deducted on your income tax return for the year in which you incurred those expenses instead of taking the deduction on the estate tax return.
Casualty or theft losses
Include any casualty and theft losses resulting from wind, rain, fire, or flood during the administration period. Make sure to add back any proceeds received from insurance or reimbursements.
Carefully review deductions
Remember that in most situations, no estate tax is due when someone passes away. This happens for a few reasons.
First, if someone is married at the date of death and the estate is left to the surviving spouse, the result is no estate tax due regardless of the size of your estate. This results from the unlimited marital deduction offered to surviving spouses.
Second, if the estate value is less than the amount of the estate tax exemption in the year you pass away, no estate tax will be due. This is the case for the vast majority of Americans.
For example, let’s assume that the estate tax exemption is $11.5 million in a given year. Therefore, if you pass away that year with an estate valued less than that amount, there is no estate tax liability.
But be careful. Just because there is no estate tax does not mean the beneficiaries cannot benefit from any estate tax deductions. Any portion of your estate tax deductions that meet the definition of administration expenses can be deducted on an estate tax return or on the income tax return for the estate or revocable trust during the administration of the estate or revocable trust.
Calculation
Example #1
At the time of Jim’s death, he was not married and had a gross estate value of $15 million. The estate tax exemption at that time is $11 million and his estate tax rate is 40%. His CPA has calculated the following estate tax deductions to review with the executor:
| Expense Type | Amount |
|---|---|
| Funeral bill | $10,000 |
| Credit card liability | $5,000 |
| Car loan | $20,000 |
| Appraisal fees | $15,000 |
| Executor fees | $12,000 |
| CPA fees | $5,000 |
| Legal fees | $15,000 |
| TOTAL DEDUCTIONS | $82,000 |
Final Thoughts
Make sure to carefully choose who will act as executors of your will and/or trustees of your revocable trust. Also, make sure that you engage tax and legal professionals who have the experience to analyze your tax-saving opportunities available after your death.
Make sure appropriate language is included in your estate planning documents to grant your executor the flexibility they need to take advantage of these opportunities. The language would be similar to: “My trustee can make tax elections that will include the right to elect whether to claim administration costs as estate tax deductions or personal income tax deductions.”
