Paying Taxes From an Estate & an Executor's Legal Duties
An estate’s debts will most likely include taxes, which must be paid even if the estate will not pass through probate. An estate’s executor is responsible for paying tax debts. If an estate is wholly composed of a trust and does not go through probate, this responsibility will fall instead to the trustee. However, if the trust does not contain all the estate’s property, the executor and trustee must work together to make sure that all tax debts are paid.
Finding the Funds to Pay Taxes
The will may indicate whether an executor must use a certain source of funds to pay the estate’s debts, including taxes. For example, the will may state that all tax debts should be paid out of a certain bank account. If the will does not speak to which source of funds an executor should use, the executor is free to reasonably choose how to pay the debt. This may involve using funds from an asset not specifically left to a beneficiary or dividing the debt among beneficiaries’ assets proportionally. If there is a trust, the trust document may instruct a trustee to pay certain taxes with trust funds if the executor makes a written request.
Income and Estate Taxes
If tax is due on any return other than the final estate income tax return, the tax is generally paid out of the estate assets. However, if tax is due on the final (or only) estate income tax return, it will pass through to the beneficiaries. This is because the assets have been transferred to the beneficiaries sometime during the final (or only) year of the estate’s existence, and that income tax liability attaches to the assets of the estate. Beneficiaries will report the income on their own tax returns and pay the tax that way.
In rare cases, an executor may need to make estimated payments (Form 1041-ES) on behalf of the estate if the estate is open long enough to have a tax year ending two or more years after the decedent’s date of death.
Estimating Federal Estate Tax
The executor of a large estate (an estate worth over $12.92 million for 2023) may wish to calculate its estimated federal estate tax before filing to ensure that the estate retains enough assets to pay. An executor should employ appraisal and tax experts to be sure of the amount owed, but having a general idea as soon as possible may help an executor manage the estate.
The IRS calculates the total taxable estate by first arriving at the estate’s gross value. An estate’s gross value is the total fair market value of each asset in the estate, which may include non-probate as well as probate property. The IRS then may apply deductions such as mortgages and other debts, estate administration expenses, or property passing to a surviving spouse or qualified charity. After deductions, the value of lifetime taxable gifts is added back into the total to arrive at the total taxable estate.
If the estate of a deceased spouse did not use their entire individual estate tax exemption, the estate of a surviving spouse can apply the unused amount to their exemption. This is known as the portability election. (The exclusion must have been transferred to the surviving spouse through their deceased spouse’s estate tax return.) For example, a husband dies and leaves $9 million to his wife. The wife later dies, leaving $14 million to her daughter. Normally, her estate would owe tax because it is valued above $12.92 million (for 2023), but since her husband did not use up his estate tax exemption, her estate can use that to increase her own exemption.
After determining whether an estate may owe federal estate tax and estimating the total taxable estate, an executor may very roughly estimate the federal estate tax owed. Most executors planning to file an estate tax return should consult with a tax expert because estate tax returns are often audited, but generally an estate will owe 40 percent of the amount in excess of the estate tax exclusion.
Real Estate and Business Taxes
If the decedent owned real estate, the executor will be responsible for paying any property taxes until the estate no longer owns the property. Similarly, an executor is responsible for paying all business taxes if the estate contains a business. Most importantly, this will include quarterly payroll taxes. An executor is ultimately responsible for these taxes, but they may hire or keep experts in place to help make appropriate payments.
An executor is typically not responsible for paying an estate’s tax debt out of their own pocket. One of the only instances in which an executor may be responsible for paying the decedent’s taxes would be if the executor was also the surviving spouse and filed a joint return. However, an executor may be required to personally pay penalties and interest if they fail to file or pay taxes on time. Taxes are high priority debts, so an executor should always confirm that the estate can pay all of its tax liability before paying other creditors or transferring estate property to beneficiaries. An executor may be required to pay a tax bill if their negligence in distributing assets caused the estate’s inability to pay its own tax bill.