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Welcome to Tax & Retirement Services of Ontario, CA


Professional tax preparation and retirement related services are provided by Enrolled Agents David De Koekkoek and Sharon Elgersma and Certified Tax Preparers Aline Anema, Victoria Beardwood and Herman Wijaya, and our office coordinator Liz De Groot.

Our office is located in Ontario, California on the northeast corner of Euclid Avenue and Walnut St. just south of the 60 Freeway.

We provide a broad range of personal and business tax preparation services including returns for all 50 states and foreign income.  We also specialize in trust and estate tax returns and provide trust administration services. 

As Enrolled Agents, we adhere to certain ethical standards and codes of professional conduct established by the National Association of Enrolled Agensts (NAEA) and the California Society of Enrolled Agents (CSEA).

This website has been developed to keep you up-to-date with the latest tax law changes and tax planning strategies.

Need a copy of your tax return? Get it fast by accessing your documents anytime with our password secured lockbox. Want the latest tax deadlines delivered to your e-mail box? Sign up for our e-mail client newsletter full of valuable tax planning strategies.

You can count on us for professional, timely and reliable services, which include the following:

Tax Preparation & Planning
  • Personal & Business Tax Returns
  • Estate, Gift & Trust Returns 
  • Out-of-State & Multi-State Returns
  • Foreign Income Returns
  • Payroll & Sales Tax Reporting 
  • Individual & Business Tax Planning
  • Authorized IRS E-file Provider
Tax Problem Assistance
  • IRS & State Audit Representation
  • Appeals & Collections
  • Non-Filers 
  • Prior-Year or Amended Returns
  • Responding to IRS / FTB Inquiries 
  • Payment Plans
Feel free to contact us by phone at 909-467-5433 or via e-mail: dave@ddktax.com or sharon@ddktax.com. We look forward to assisting you with all of your tax and financial needs.

Aline Anema 
is our administrative assistant for tax and investment matters.  aline@ddktax.com

Liz De Groot is our administrative assistant for office and client support.  liz@ddktax.com

Herman Wijaya is our primary bookkeeping and efiling person.  herman@ddktax.com

Shannon Fuller is our tax season assistant, standing substitute and special projects person.

Are You Ready?

If you’re like most taxpayers, you find yourself with an ominous stack of “homework” around TAX TIME! Unfortunately, the job of pulling together the records for your tax appointment is never easy, but the effort usually pays off when it comes to the extra tax you save! When you arrive at your appointment fully prepared, you’ll have more time to:
  • Consider every possible legal deduction;

  • Better evaluate your options for reporting income and deductions to choose those best suited to your situation;

  • Explore current law changes that affect your tax status;

  • Talk about possible law changes and discuss tax planning alternatives that could reduce your future tax liability.

Choosing Your Best Alternatives

The tax law allows a variety of methods for handling income and deductions on your return. Choices made at the time you prepare your return often affect not only the current year, but later-year returns as well. When you’re fully prepared for your appointment, you will have more time to explore all avenues available for lowering your tax.

For example, the law allows choices in transactions like:

Sales of property. . . .

If you’re receiving payments on a sales contract over a period of years, you are sometimes able to choose between reporting the whole gain in the year you sell or over a period of time, as you receive payments from the buyer.

Depreciation . . . .

You’re able to deduct the cost of your investment in certain business property using different methods. You can either depreciate the cost over a number of years, or in certain cases, you can deduct them all in one year.

Where to Begin?

Ideally, preparation for your tax appointment should begin in January of the tax year you’re working with. Right after the new year, set up a safe storage location - a file drawer, a cupboard, a safe, etc. As you receive pertinent records, file them right away, before they’re forgotten or lost. By making the practice a habit, you’ll find your job a lot easier when your actual appointment date rolls around.

Other general suggestions to consider for your appointment preparation include . . .

• Segregate your records according to income and expense categories. For instance, file medical expense receipts in an envelope or folder, interest payments in another, charitable donations in a third, etc. If you receive an organizer or questionnaire to complete before your appointment, make certain you fill out every section that applies to you. (Important: Read all explanations and follow instructions carefully to be sure you don’t miss important data - organizers are designed to remind you of transactions you may miss otherwise.)

  • Keep your annual income statements separate from your other documents (e.g., W-2s from employers, 1099s from banks, stockbrokers, etc., and K-1s from partnerships). Be sure to take these documents to your appointment, including the instructions for K-1s!

  • Write down questions you may have so you don’t forget to ask them at the appointment. Review last year’s return. Compare your income on that return to the income for the current year. For instance, a dividend from ABC stock on your prior-year return may remind you that you sold ABC this year and need to report the sale.

  • Make certain that you have social security numbers for all your dependents. The IRS checks these carefully and can deny deductions for returns filed without them.

  • Compare deductions from last year with your records for this year. Did you forget anything?

  • Collect any other documents and financial papers that you’re puzzled about. Prepare to bring these to your appointment so you can ask about them.

Accuracy Even for Details

To ensure the greatest accuracy possible in all detail on your return, make sure you review personal data. Check name(s), address, social security number(s), and occupation(s) on last year’s return. Note any changes for this year. Although your telephone number isn’t required on your return, current home and work numbers are always helpful should questions occur during return preparation.

Marital Status Change

If your marital status changed during the year, if you lived apart from your spouse, or if your spouse died during the year, list dates and details. Bring copies of prenuptial, legal separation, divorce, or property settlement agreements, if any, to your appointment.

Dependents

If you have qualifying dependents, you will need to provide the following for each:

• First and last name
• Social security number
• Birthdate
• Number of months living in your home
• Their income amount (both taxable and nontaxable)

If you have dependent children over age 18, note how long they were full-time students during the year.

To qualify as your dependent, an individual must pass several strict dependency tests. If you think a person qualifies as your dependent (but you aren’t sure), tally the amounts you provided toward his/her support vs. the amounts he/she provided. This will simplify making a final decision about whether you really qualify for the dependency deduction.

Some Transactions Deserve Special Treatment

Certain transactions require special treatment on your tax return. It’s a good idea to invest a little extra preparation effort when you have had the following transactions:

Sales of Stock or Other Property: All sales of stocks, bonds, securities, real estate, and any other type of property need to be reported on your return, even if you had no profit or loss. List each sale, and have the purchase and sale documents available for each transaction. Purchase date, sale date, cost, and selling price must all be noted on your return. Make sure this information is contained on the documents you bring to your appointment.

Gifted or Inherited Property:
If you sell property that was given to you, you need to determine when and for how much the original owner purchased it. If you sell property you inherited, you need to know the date of the decedent’s death and the property’s value at that time. You may be able to find this information on estate tax returns or in probate documents.  If the property was inherited from someone who died in 2010, special complicated rules may apply in determining your inherited basis.  Please call for further details.

Reinvested Dividends:
You may have sold stock or a mutual fund in which you participated in a dividend reinvestment program. If so, you will need to have records of each stock purchase made with the reinvested dividends. If you sold mutual fund shares, you may have received a statement from the fund that shows your average cost basis for the shares sold and any “wash sale” adjustments; be sure to bring this statement to your appointment along with the purchase and reinvestment records you have.

Sale of Home:
The tax law provides special breaks for home sale gains, and you may be able to exclude all (or a part) of a gain on a home if you meet certain ownership, occupancy, and holding period requirements. If you file a joint return with your spouse and your gain from the sale of the home exceeds $500,000 ($250,000 for other individuals), record the amounts you spent on improvements to the property. Remember too, possible exclusion of gain applies only to a primary residence, and the amount of improvements made to other homes is required regardless of the gain amount. Be sure to bring a copy of the sale documents (usually the closing escrow statement) with you to the appointment.

Purchase of a Home:
  If you purchased a home during 2010 and you are a first-time homebuyer or a long-time homeowner, you may qualify for a substantial tax credit.  Be sure to bring a copy of the escrow closing statement if you purchased a home.

Vehicle Purchase: 
If the car was a hybrid vehicle or one that qualifies as a lean burn vehicle, you may qualify for a special credit.  Please bring the purchase statement to the appointment with you.

Home Energy-Related Expenditures:
If you made home modifications to conserve energy (such as special windows, roofing, doors, etc.) or installed solar, geothermal, or wind power generating systems, please bring the details of those purchases and the manufacturer’s credit qualification certification to your appointment.  You may qualify for a substantial energy-related tax credit.

Ponzi Scheme or Bank Failure Losses: 
If you suffered losses as the result of a Ponzi scheme or as the result of a bank failure, there is special tax treatment for these types of losses.  Please be prepared with the details of the losses and the amounts lost.

Car Expenses:
Where you have used one or more automobiles for business, list the expenses of each separately. The government requires that you provide your total mileage, business miles, and commuting miles for each car on your return, so be prepared to have them available. If you were reimbursed for mileage through an employer, know the reimbursement amount and whether the reimbursement is included in your W-2.

Charitable Donations:
Cash contributions (regardless of amount) must be substantiated with a bank record or written communication from the charity showing the name of the charitable organization, date and amount of the contribution.  Cash donations put into a “Christmas kettle,” church collection plate, etc., are not deductible unless verified by receipt from the charitable organization. For clothing and household contributions, the items donated must generally be in good or better condition, and items such as undergarments and socks are not deductible. A record of each item contributed must be kept, indicating the name and address of the charity, date and location of the contribution, and a reasonable description of the property. Contributions valued less than $250 and dropped off at an unattended location do not require a receipt. For contributions of $500 or more, the record must also include when and how the property was acquired and your cost basis in the property. For contributions valued at $5,000 or more and other types of contributions, please call this office for additional requirements.


There is a fraud risk related to the Electronic Federal Tax Payment System (EFTPS) that you need to be aware of. 

Always remember that the IRS does not initiate taxpayer contact by e-mail.  Therefore, if you receive an e-mail that appears to be from a tax agency telling you that your federal electronic funds transfer (EFT) payment did not go through, it is part of a phishing scheme and you should not respond to it.  The perpetrators of this scheme have duplicated the IRS’s EFTPS logo and other characteristics of that system in an attempt to convince taxpayers that it is an official e-mail from the IRS.  It is not!

If you receive a message claiming to be from the IRS or EFTPS, take the following steps:

1. Do not reply to the sender, access links on the site, or submit any information to them.

2. Forward the message as-is immediately to IRS at phishing@irs.gov.

3. Visit the IRS website to find out how to report and identify phishing, e-mail scams and bogus IRS websites.

4. If you receive a suspicious e-mail or discover a website posing as the IRS, please forward the e-mail or URL information to the IRS at phishing@irs.gov.

5. EFTPS is a tax payment system provided free by the U.S. Department of Treasury.

Whenever you receive a communication from the IRS, it is generally good practice to contact this office before responding.

Taxpayers often question how long records must be kept and how long the IRS has to audit a return after it is filed. It all depends on the circumstances! In many cases, the federal statute of limitations can be used to help you determine how long to keep records. With certain exceptions, the statute for assessing additional tax is 3 years from the return due date or the date the return was filed, whichever is later. However, the statute of limitations for many states is one year longer than the federal. The reason for this is that the IRS provides state taxing authorities with federal audit results. The extra time on the state statute gives states adequate time to assess tax based on any federal tax adjustments.

In addition to lengthened state statutes clouding the recordkeeping issue, the federal 3-year rule has a number of exceptions:

  • The assessment period is extended to 6 years instead of 3 years if a taxpayer omits from gross income an amount that is more than 25 percent of the income reported on a tax return.
  • The IRS can assess additional tax with no time limit if a taxpayer: (a) doesn't file a return; (b) files a false or fraudulent return in order to evade tax, or (c) deliberately tries to evade tax in any other manner.
  • The IRS gets an unlimited time to assess additional tax when a taxpayer files on an unsigned return.

If no exception applies to you, for federal purposes, you can probably discard most of your tax records that are more than 3 years old; add a year or so to that if you live in a state with a longer statute.

Example: Sue filed her 2008 tax return before the due date of April 15, 2009. She will be able to safely dispose of most of her records after April 15, 2012. On the other hand, Don filed his 2008 return on June 1,  2009. He needs to keep his records at least until June 1,  2012. In both cases, the taxpayers may opt to keep their records a year or two longer if their states have a statute of limitations longer than 3 years.

Important note: Even if you discard backup records, never throw away your file copy of any tax return (including W-2s). Often the return itself provides data that can be used in future tax return calculations or to prove amounts related to property transactions, social security benefits, etc. You should keep certain records for longer than 3 years. These records include:

  • Stock acquisition data. If you own stock in a corporation, keep the purchase records for at least 4 years after the year you sell the stock. This data will be needed in order to prove the amount of profit (or loss) you had on the sale.
  • Stock and mutual fund statements where you reinvest dividends. Many taxpayers use the dividends they receive from a stock or mutual fund to buy more shares of the same stock or fund. The reinvested amounts add to basis in the property and reduce gain when it is finally sold. Keep statements at least 4 years after final sale.
  • Tangible property purchase and improvement records. Keep records of home, investment, rental property, or business property acquisitions AND related capital improvements for at least 4 years after the underlying property is sold.

If you have been procrastinating about filing your 2011 tax return or have other prior year returns that have not been filed, you should consider the consequences.

Taxpayers should file all tax returns that are due, regardless of whether or not full payment can be made with the return. Depending on an individual's circumstances, a taxpayer filing late may qualify for a payment plan. All payment plans require continued compliance with all filing and payment responsibilities after the plan is approved.

Facts about Filing Tax Returns
  • Failing to file a return or filing late can be costly. If taxes are owed, a delay in filing may result in penalty and interest charges that could substantially increase your tax bill. The late filing and payment penalties are a combined 5% per month (25% maximum) of the balance due.

  • If a refund is due, there is no penalty for failing to file a tax return. But by waiting too long to file, you can lose your refund. In order to receive a refund, the return must be filed within three years of the due date. If you file a return and later realize you made an error on the return, the deadline for claiming any refund due is three years after the return was filed, or two years after the tax was paid, whichever expires later.

  • Taxpayers who are entitled to the Earned Income Tax Credit must file a return to claim the credit, even if they are not otherwise required to file. The return must be filed within three years of the due date in order to receive the credit.

  • If you are self-employed, you must file returns reporting self-employment income within three years of the due date in order to receive Social Security credits toward your retirement.
Taxpayers who continue to not file a required return and fail to respond to IRS requests to do so may be subject to a variety of enforcement actions, all of which can be unpleasant. Thus, if you have returns that need to be filed, please call this office so we can help you bring your tax returns up-to-date, and, if necessary, advise you about a payment plan.


If you have received an inheritance or anticipate receiving one in the future, this article may answer many of your questions. The process of claiming an inheritance can be quite complex, and it helps to understand the basics and to be aware of potential tax liabilities.

An inheritance is generally received after all applicable taxes have been paid along with any outstanding liabilities the decedent may have had. Exactly how the estate is handled will depend upon whether the assets were owned individually or in a trust. Without going into the intricacies of estates, trusts, and probate, the result for a beneficiary will generally be the same. Inherited items on which the decedent had already paid taxes and for which the estate tax (if any) has been paid will pass to the beneficiary tax-free. On the other hand, items of income that had not previously been taxed to the beneficiary and any appreciation or depreciation of assets acquired from the decedent will have tax implications. Some possible scenarios are provided below:
  • Bank Account - Take, for instance, an inherited bank account worth $25,000, where the funds are not immediately distributed to the heir. The $25,000 account earns $375 of interest income after the decedent's date of death. Out of the $25,375 that is received, the $25,000 is tax-free, but the $375 is taxable as interest income.

  • Capital Asset - The basis for gain or loss from the sale of an inherited capital asset, such as stock, real estate, collectibles, etc., is generally based on the value of the asset at the time of the decedent's death. This is one reason that qualified appraisals are so important. To explain this further, let's assume that a vacant parcel of land is inherited with a date of death appraisal that values it at $15,000. If that property is sold for a net price of $15,000, there is neither gain nor loss and the $15,000 is tax-free to the beneficiary. If, on the other hand, the net sales price is more or less than the $15,000, there would be a reportable capital gain or loss. For capital gains tax purposes, the holding period is important. Assets held over one year are generally taxed at substantially less than those held for a shorter period of time. However, for inherited property, the beneficiary receives long-term treatment immediately, whether or not the decedent or the beneficiary had held it over one year. If there are expenses associated with selling the asset, then those expenses are deductible in figuring the gain or loss.

  • IRA or other Qualified Plan - Suppose the decedent had a traditional IRA account and the distributions from that account were taxable to the decedent. If you inherit that account, the distributions will be taxable to you as the beneficiary. Why is that? Because the decedent had never paid taxes on the income that went to fund the traditional IRA and therefore you, the beneficiary, will be stuck with the tax liability. The good news is that there are options for taking the income over a number of years, which can soften the tax blow.

  • Life Insurance Proceeds - Generally, the proceeds from a life insurance policy are tax-free to the heirs. However, if the policy is not paid immediately, as most are not, the insurance company will include interest. That interest is taxable to the heirs.

  • Annuities and Installment Sale Notes - If the decedent purchased an annuity or had an installment sale note from the property he previously sold, the decedent's basis will be tax-free, but the heirs will be obligated to pay tax on any amount received in excess of the decedent's basis. For an annuity, the decedent's basis would be what he paid for it. For an installment note, payments include: (1) a return of a portion of the asset's cost (basis), which is not taxable; (2) a portion from the prior sale of the asset, which is taxable as a capital gain; and (3) taxable interest on the note.
A trust or estate is required to file an income tax return and to report income earned by the estate or trust after the decedent's passing and before the assets are distributed to the heirs. Each heir will generally receive a form called Schedule K-1(1041). It will include that heir's share of income and must be included on the heir's individual tax return. Although infrequent because the taxes are generally higher, the trust or estate may pay the income tax on the income. The executor or trustee is responsible for making sure the required tax returns are filed and for sending K-1s to the heirs.

There may be taxable income to the heir even though the inheritance has not yet been received. In addition, there are other factors to consider that have not been discussed. Therefore, during your tax appointment, it is important to let our tax professionals know if you are expecting an inheritance.


A question frequently asked by individuals who are approaching the age at which they can draw Social Security benefits is, "At what age should I begin taking my benefits?" To make an informed decision, a number of issues should be considered, including how doing so affects your benefits, what the tax ramifications are, the historical longevity of your family, and your financial needs. But first, let's review how the decision will impact your Social Security benefits based on when you decide to retire.
  • Wait Until "Normal" Retirement Age - Individuals who retire at the normal retirement age receive the standard Social Security benefits based on their lifetime earnings. The "normal" retirement age is no longer 65 years of age. For individuals born after 1937, "normal" retirement age is now based on a sliding scale and varies according to the year of birth, as indicated in the table below.



  • Take the Benefits Early - You may begin taking benefits as early as age 62 if you are willing to receive a reduced amount over your lifetime. The amount of the reduction is based on how early the benefits are taken. Here is an example of how the reduction works. If your full retirement age is 67, then the approximate reduction for taking the benefits at an earlier age is as follows:



  • Take the Benefits Late - Some people decide to continue working full-time beyond retirement age. In that case, their Social Security benefits increase in the following two ways:

    o Each additional year that a person works adds another year of earnings to his or her Social Security record. Higher lifetime earnings may result in higher benefits when one retires.

    o In addition, a person's benefit will be increased by a certain percentage (see table below) if he or she delays retirement. Such increases, called delayed retirement credits, will be added in automatically from the time at which the individual reaches full retirement age until he or she begins taking benefits or reaches 70 years of age 70.

You may also wish to take your life expectancy into consideration. If your family history indicates a shorter than average life expectancy, you may wish to take the benefits earlier than later. On the other hand, if you begin drawing your Social Security benefits prior to reaching full retirement age, and you continue to earn wages or self-employment income--perhaps by continuing to work part-time--your benefits may be reduced if your earnings exceed an annual limit. For example, if you were born in 1950, your normal retirement age is 66, but you could begin receiving Social Security benefits at age 62 in 2012. If you were to do so, but you continued to work, your benefits would be reduced by $1 for each $2 above $14,640 of wages or net self-employment income.

Social Security is taxable once an individual's income for the year, including one-half of the Social Security income and otherwise nontaxable interest income, exceeds $25,000 ($32,000 for married taxpayers filing jointly). Thus, the benefits are not taxable at all for very low-income taxpayers, and as the taxpayer's income increases, a greater portion of the benefits become taxable. However, no more than 85% of the benefits are added to taxable income. Taxpayers who are still working or who earn substantial other income may thus not wish to utilize the "early" option, since doing so results in a reduced benefit that is subject to taxation and thereby further reduced.

Everyone’s situation is unique, and there are a number of different issues to consider. If you would like to set up an appointment in order to discuss your specific circumstances, please give this office a call.




If you use independent contractors to perform services for your business and you pay them $600 or more for the year, you are required to issue them a Form 1099-MISC after the end of the year to avoid facing the loss of the deduction for their labor and expenses. The 1099s for 2012 must be provided to the independent contractor no later than January 31 of 2013.

It is not uncommon to, say, have a repairman out early in the year, pay him less than $600, and then use his services again later and have the total for the year exceed the $600 limit. As a result, you overlook getting the information needed to file the 1099s for the year. Therefore, it is good practice to have individuals who are not incorporated complete and sign the IRS Form W-9 the first time you use their services. Having a properly completed and signed Form W-9s for all independent contractors and service providers eliminates any oversights and protects you against IRS penalties and conflicts.

IRS Form W-9 is provided by the government as a means for you to obtain the data required to file the 1099s for your vendors. It also provides you with verification that you complied with the law should the vendor provide you with incorrect information. We highly recommend that you have a potential vendor complete the Form W-9 prior to engaging in business with them. The form can either be printed out or filled onscreen and then printed out. A Spanish-language version is also available. The W-9 is for your use only and is not submitted to the IRS.

To avoid a penalty, copies of the 1099s must to be sent to the IRS by February 28, 2013. They must be submitted on magnetic media or on optically scannable forms.

This firm provides 1099 preparation services. If you need assistance or have questions, please give this office a call.


We hope you’ll be ringing out a successful financial year at month’s end. In any case, here’s what you should know about preparing for 2013.

End of the year. QuickBooks has been hard at work for the past 11+ months, recording and tracking and storing all of that financial data that you’ve entered so faithfully.

But when you turn the calendar page and make a new start January 1, your accounting software could use some closure on the year that’s just passed. Here are some actions you can take to ring out the old and ring in the new. There’s more you can do (we can help you with the advanced activities) but we’ll just hit the highlights here.
  • Reconcile, reconcile, reconcile. Yes, we know it’s not one of your favorite chores, but we really like to see all bank and credit card accounts reconciled by the end of the year if at all possible. Void all checks necessary and enter missing transactions. 


Figure 1: You can make yourself crazy looking for a nickel when you’re reconciling, but it’s a critical function.
  • Make accrual adjustments. This is complicated, and it only applies if you accrue payroll and liabilities or prepay expenses that are then carried as assets. We’ll need to create journal entries for you.

  • Close your books. This is totally optional. It depends on whether you want to lock 2012 data to everyone except those who have the password and permissions. If you don’t close them, you’ll have easier access to last year’s transaction details. Regardless of what you choose, QuickBooks will automatically make some year-end adjustments.

  • Do a physical inventory. Then compare this with what QuickBooks says. Reports | Inventory | Physical Inventory Worksheet.


Figure 2: It’s good to match up your physical inventory count with QuickBooks occasionally, and the end of the year is as good a time as any.

  • Run income tax reports. As you know, QuickBooks lets you assign tax lines to tax-related transactions. Use the Income Tax Preparation Report and the Income Tax Summary Report. Let us know about any errors or omissions.

  • Check W-2 and 1099 data. You can’t create these forms, of course, until after your final 2012 payroll, but you can get a head start. Ask employees to verify their names, addresses and Social Security numbers for accuracy. Also, make sure that your EIN and SEIN are correct, as well as the company address.

  • Clean up, back up. We can monitor the health of your QuickBooks data file anytime. But year-end is a good time to scrutinize your software’s performance. Has it slowed down, started crashing or returning error messages? We can troubleshoot to find the problem and clean it up. We’re sure you’ve been backing up your file faithfully, but archive all of 2012 and store it in a very safe offsite location – or use Intuit Data Protect for online storage. 


Figure 3: Frequent backups are critical, but you should be sure to have a copy of your entire 2012 data file stored somewhere safe.
  • Double-check tax liabilities. If you’re handling your own payroll, look back to see whether all of your payments and filings have been completed.
Thanks for another year.

Again, these are suggestions. QuickBooks does not require you to do any of them. There’s more you can do, and you will need assistance with some of these. So let’s set up a December or early January meeting to get you started right in 2013.

We want to take this opportunity to thank you for letting us serve your company in 2012. We certainly appreciate your business, and we’re happy to do what we can to help your business prosper.

P.S. It’s not too early to think about taxes, so let us know if you want to get a jump on planning and preparation in January.


When it comes to inheritances, there is considerable misunderstanding with taxpayers.  Many believe that inheritances are taxable.  That may or may not be true depending upon what is inherited. For example, if a taxpayer inherits cash, stocks and bonds, or real estate from a decedent, he or she is not taxed on these assets upon receipt (but income such as interest, dividends or rents generated from the inherited assets after the property is transferred to the taxpayer is reportable). On the other hand, if a Traditional IRA is inherited from a decedent (funds on which taxes were never paid by the decedent), the Traditional IRA will generally be taxable to the taxpayer; although, there will be certain options on when to take the taxable income. This discussion explains the role of an executor, the tax treatment for several types of assets that are frequently inherited, the rules regarding tax basis for inherited property, the tax reporting and associated forms likely to be encountered by beneficiaries, and who may claim the deduction when the decedent’s property is donated to charity. 

• Executor’s Duties and Compensation   
• Life Insurance 
• Beneficiary Tax Basis  
• Inherited IRAs   
• Inherited Personal Residence 
• Depreciable Assets  
• Income in Respect of a Decedent  
• Estate’s Income Tax Reporting   
• Donating Decedent’s Property to Charity

Executor’s Duties and Compensation 

Throughout most of this article, we refer to an “executor” of the estate. By legal definition, an executor is named in a decedent’s will to administer the estate and distribute the decedent’s property as the decedent directed. If no will exists, no executor was named in the will, or the named person cannot or will not serve as executor, a court will appoint an administrator, whose duties and responsibilities are generally the same as those of an executor. For estate tax purposes, the term executor can also include anyone in actual possession of the decedent’s property if no executor or administrator is appointed, qualified and acting within the U.S. A broad term that is sometimes used to describe an executor, administrator or other person who is in charge of the decedent’s property is personal representative. For simplicity, we’ll generally use “executor.”

The primary duties of an executor are to collect all of the decedent’s assets, pay creditors, and distribute the remaining assets to the heirs or other beneficiaries. Other specific duties of the executor include applying for an employer identification number (EIN) for the estate, timely filing required income and estate tax returns (including the decedent’s final Form 1040, plus Forms 1041 and 706 related to the estate), and paying the tax determined up to the date the executor is discharged from duties. The executor, who is oftentimes a friend or relative of the deceased individual, is not required to personally prepare the tax returns or legal documents needed to administer the estate, and generally will hire an attorney and professional tax preparer to assist in these matters. The fees charged by these professionals are paid from the assets of the estate.

Sometimes heirs or beneficiaries become impatient with the executor because they think that the administration of the decedent’s estate is moving too slowly. Beneficiaries need to realize that the executor must work within the timeframes of the courts and attorneys, especially when an estate has to go through the probate process. Additionally, the executor may need to delay the distribution of some or all of the estate’s assets until required tax returns are filed, taxes paid and tax clearances issued by the IRS. It is unusual for an estate to be completely settled in less than one year, and often it can take 18 to 24 months or longer.

Executors generally are eligible to receive compensation for their work, payable from the estate’s assets. In some states, the compensation is based on the value of the estate and may equal that paid to the attorney hired to take care of the estate’s legal matters. Thus, the executor’s fees can be several thousand dollars. All executors or other personal representatives who are compensated by an estate for their services must include those fees in their gross income on their personal tax returns. Professional executors or administrators must also pay self-employment tax on these fees. A person who serves as an executor or administrator in an isolated instance, such as a friend or relative of the decedent, pays self-employment tax on executor fees only if a trade or business is included in the estate’s assets, the executor actively participates in the business, and the fees are related to the operation of the business. If you are the executor of an estate and also the sole beneficiary, you may want to waive any executor fees. By doing so, the net amount of the estate’s assets that will pass to you will increase by the foregone fee, and you will not have to pay income tax on that amount. However, if the estate is subject to estate tax, this strategy may not be appropriate because the estate will lose the benefit of the executor fee deduction, and usually an estate’s tax bracket is higher than the beneficiary’s income tax bracket. Thus, there would be a greater net tax benefit if you receive the executor’s fee, pay tax on that income, and the estate takes a deduction for the fee.

Life Insurance

Life insurance proceeds that you receive because of the insured’s death are not taxable to you unless the policy was turned over to you for a price. This applies even if the proceeds are paid under an accident or health insurance policy or an endowment contract. If the proceeds are received in installments, part of each installment is excludable from your income. The excludable part is figured by dividing the amount held by the insurance company – usually the lump-sum payable at the insured person’s death – by the number of installments to be paid. The portion that is not excludable is taxable as interest income.

Beneficiary Tax Basis

Basis is a tax term that defines the amount of a taxpayer’s investment in a property. For property that is purchased, the initial tax basis is the cost of the property, but that basis can be adjusted up or down by events that occur after the property is acquired. Basis is used for figuring depreciation (on business property) and is the dollar value from which a taxpayer measures his gain or loss when an asset is sold.  Generally, when you inherit an asset from a deceased individual’s estate or trust, you receive the asset at its fair market value (FMV) determined as of the individual’s date of death.  The inherited basis can be more or less than what the decedent paid for the property.  This change in basis is sometimes referred to as a step-up or step-down in basis.  Thus, if for example, you inherited 100 shares of stock that the decedent originally purchased for $40 a share (total cost $4,000) that is worth $100 per share (total value $10,000) when the decedent died, you will receive the stock free of any income tax and will have an inherited basis of $10,000.  Any future gain or loss will be measured from the $10,000 basis.

As is the case with property that is purchased, the basis of inherited property may have to be adjusted during the beneficiary’s ownership period. Situations that require basis adjustment include stock splits, nontaxable dividend distributions, improvements to real property, and casualty losses, among others. The important point is that, for property acquired from a decedent, the starting place for making any required adjustments is the initial inherited basis.

CAUTION 2010: Legislation enacted nearly 10 years ago repeals the estate tax for individuals dying in 2010, and then brings it back for those dying after 2010.  Although many had thought Congress would revoke the repeal for 2010 and keep the tax at 2009’s level that has not happened yet.  Without Congressional action (there are active legislative discussions taking place), the basis for items inherited in 2010 will be based upon a more complicated “modified carryover basis”.  Thus, for 2010, inherited basis becomes the lesser of the  decedent’s adjusted basis, or the FMV at the date of death plus an allowable aggregate basis increase of $1,300,000 plus loss carryovers and built in losses, and if applicable a spousal $3,000,000 property basis increase.

Joint Ownership - A beneficiary who is a joint owner of a property with the decedent will have a basis made up of two parts: his or her own basis for the original ownership portion and an inherited basis for the part that was inherited. For example, a father and son each owned 50% of a lot they purchased together for $10,000 several years ago.  At the time of the father’s death in 2009, the lot was worth $20,000 and the son was the beneficiary of the father’s share of ownership. The son’s new basis in the property is $15,000 (50% of $10,000 plus 50% of $20,000).    

Community Property - A husband and wife who are residents of a community property state* generally are considered to each own half of the community property. At the death of either spouse, the total value of the community property – even the surviving spouse’s part – becomes the basis of the entire property. This rule applies when at least half the value of the community property interest is includible in the decedent’s gross estate, whether or not the estate must file a return. For example, a husband and wife owned community property that had an adjusted basis of $100,000 at the time the husband died in 2009. The fair market value at his date of death was $150,000, and half the FMV was includible in the husband’s estate. The husband’s will named his sister as the beneficiary of his half of the property. The wife and the sister will each have an inherited basis of $75,000. If the wife was the sole beneficiary, her new basis as of the husband’s date of death would be $150,000.

*Community property states are Alaska (by election), Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin.

Valuation Other than at Date of Death – Under some circumstances, the executor of the decedent’s estate may choose to use the fair market value on the “alternate valuation date” instead of the decedent’s date of death. The alternate valuation date is the date six months after the date of death. This alternate date is chosen when using the values of all assets in the estate at that date will produce a lower estate tax than when the date of death valuation is used. While using the alternate valuation saves estate tax, it means that the beneficiary’s basis of inherited property will be lower than if the date of death valuation applied. Thus, when the beneficiary sells the inherited property in the future, his or her gain will be more (or the loss will be less) than if the date of death FMV applied. The beneficiary is required to use the same basis that the executor used for the estate tax return. The executor should provide a record of the inherited basis for each asset the beneficiary receives, regardless of which valuation date is used. Note: The beneficiary’s basis in assets inherited from a decedent dying in 2010 is determined by a different set of rules.  See CAUTION 2010 above.

Holding Period of Inherited Property – Gains from the sale of capital assets such as stocks, bonds, unimproved real estate, etc., that are held “long-term” are given beneficial tax treatment. This special treatment is in the form of lower tax rates. To qualify as long-term, generally an asset has to be held more than one year. An exception is made for inherited assets, which automatically receive long-term treatment regardless of how long the decedent or the beneficiary owned the property. Note: The beneficiary’s holding period in assets inherited from a decedent dying in 2010 may be determined differently if the decedent’s basis is carried over.  See CAUTION 2010 above.

Inherited IRAs 

A number of factors are involved in determining how much, if any, of an IRA account that you inherit is taxable to you, and when the taxable amount is includible in your income. These factors include which type of IRA (Traditional or Roth) is inherited, who the beneficiaries are (spouse, non-spouse, trust or estate), the deceased IRA account owner’s age at death, and whether or not distributions from the IRA were required to start before the decedent’s death. With a Traditional IRA, the account owner is required to begin taking annual minimum distributions by April 1 of the year following the year in which he or she reaches age 70½. Roth IRA account owners are not required to take distributions during their lifetimes. The following situations explain the options available to beneficiaries of these IRAs.

Traditional IRA inherited by spouse and decedent owner was under 70½: – If the spouse takes a distribution of the IRA account as a lump-sum, the spouse will pay income tax on the distribution on the tax return for the year of the distribution, but no penalty for “early” withdrawal will be due, even if the spouse is under age 59½.

• Transfer to spouse’s own existing or new IRA – This choice is available only if the spouse is the sole beneficiary of the IRA. If the deceased account owner had not already taken the required minimum distribution (RMD) for the year of death, the spouse must do so. A spouse who is under age 59½ is regulated by the same distribution rules as if the IRA had been his or hers originally, so distributions cannot be taken before age 59½ without incurring the 10% penalty (except for the required year-of-death RMD or if one of the general exceptions applies).

• Transfer to Inherited IRA held in own name – The annual RMD based on life expectancy must begin no later than December 31 of the year following the original account owner’s death. Also, if no RMD had been taken by the decedent in the year of death, an RMD must be taken from the Inherited IRA by December 31 of the year the original account owner died. The annual distributions are spread over the longer of the surviving spouse’s single life expectancy using his or her age in the calendar year following the year of death and refigured each year, or the deceased account owner’s remaining life expectancy. Each distribution is taxed, but the 10% early distribution penalty does not apply. If there are other beneficiaries besides the spouse, separate accounts must be established by the end of the year following the year of death; otherwise, distributions will be based on the life expectancy of the oldest beneficiary, which will cause the amount of the distribution to be greater than otherwise required for the younger beneficiaries.  

Traditional IRA inherited by spouse and decedent owner was 70½ or older:

• Lump-sum distribution – Same result as for a decedent who was under 70½ (see above).

• Transfer to spouse’s own existing or new IRA – This choice is available only if the spouse is the sole beneficiary of the IRA. If the deceased account owner had not already taken the required minimum distribution (RMD) for the year of death, the spouse must do so. A spouse who is under age 59½ is regulated by the same distribution rules as if the IRA had been his or hers originally, so distributions cannot be taken before age 59½ without incurring the 10% penalty (except for the required year-of-death RMD or if one of the general exceptions applies).

• Transfer to Inherited IRA held in own name – The annual RMD based on life expectancy must begin no later than December 31 of the year following the original account owner’s death. Also, if no RMD had been taken by the decedent in the year of death, an RMD must be taken from the Inherited IRA by December 31 of the year the original account owner died. The annual distributions are spread over the longer of the surviving spouse’s single life expectancy using his or her age in the calendar year following the year of death and refigured each year, or the deceased account owner’s remaining life expectancy. Each distribution is taxed, but the 10% early distribution penalty does not apply. If there are other beneficiaries besides the spouse, separate accounts must be established by the end of the year following the year of death; otherwise, distributions will be based on the life expectancy of the oldest beneficiary, which will cause the amount of the distribution to be greater than otherwise required for the younger beneficiaries. 


Traditional IRA inherited by non-spouse and decedent owner was under 70½:

• Lump-sum distribution – Same result as if the spouse was beneficiary (see above).

• Transfer to Inherited IRA held in own name, 5-year withdrawal – Distribution can be spread over time, but all of the assets in the account need to be distributed by December 31 of the fifth year after the year in which the account owner died. Distributions are taxed as received, but are not subject to the 10% early withdrawal penalty.

• Transfer to Inherited IRA held in own name, distributions over life expectancy – A required minimum distribution based on the beneficiary’s life expectancy must begin no later than December 31 of the year following the year of the original account owner’s death. The annual distributions are spread over the beneficiary’s single life expectancy based on his or her age in the calendar year following the year of death and reduced by one each year thereafter. If there are multiple beneficiaries, separate accounts should be established by December 31 of the year following the year of death in order for each beneficiary to use his or her own life expectancy. Otherwise, life expectancy is based on that of the oldest beneficiary. Each distribution is taxed, but the 10% early distribution penalty does not apply.

Traditional IRA inherited by non-spouse and decedent owner was age 70½ or older:

• Lump-sum distribution – Same result as if the spouse was beneficiary (see above).

• Transfer to Inherited IRA held in own name - The annual RMD based on life expectancy must begin no later than December 31 of the year following the original account owner’s death. Also, if no RMD had been taken by the decedent in the year of death, an RMD must be taken from the Inherited IRA by December 31 of the year the original account owner died. The annual distributions are spread over the longer of the beneficiary’s single life expectancy using his or her age in the calendar year following the year of death and reduced by one each year, or the deceased account owner’s remaining life expectancy. If there are multiple beneficiaries, separate accounts should be established by December 31 of the year following the year of death in order for each beneficiary to use his or her own life expectancy. Otherwise, life expectancy is based on that of the oldest beneficiary. Each distribution is taxed, but the 10% early distribution penalty does not apply.

Traditional IRA with Basis – Generally, while the account owner was alive, he or she would have deducted the contributions made to a Traditional IRA on the income tax returns for the years of the contributions. However, if the taxpayer participated in an employer’s retirement plan and was not eligible to deduct IRA contributions because of income limitations, he or she was still allowed to contribute to the IRA but had to designate the contribution as being nondeductible. In this situation, the nondeductible contribution amounts became the taxpayer’s basis in the IRA, since tax had already been paid on the funds used to make the contributions. If you inherit a traditional IRA from a person who had a basis in the IRA because of nondeductible contributions, that basis remains with the IRA. This means that each distribution you take from the inherited IRA will be partly nontaxable. Unless you are the decedent’s spouse and choose to treat the IRA as your own, you cannot combine this basis with any basis you have in your own Traditional IRAs or others you may have inherited. Form 8606 is used to figure your taxable and nontaxable portions of the IRA distribution. How will you know what the decedent’s IRA basis is? This information can be found on the Forms 8606 the decedent filed with his or her tax returns. The executor for the decedent’s estate should have access to that information and should make it available to you as the beneficiary of the IRA.

Federal Estate Tax Deduction – A beneficiary may be able to claim a deduction for estate tax resulting from certain distributions from a Traditional IRA. The beneficiary can deduct the estate tax paid on any part of a distribution that is income in respect of a decedent, which includes IRAs. The deduction is taken for the tax year the income is reported. See more about income in respect of a decedent below.

Roth IRAs – Roth IRAs are not subject to the annual required minimum distribution rules during the account owner’s lifetime. But after the owner’s death, distributions may need to be made. Roth IRA distributions, whether to a living owner or a beneficiary, are made up of after-tax contributions and earnings. Contribution amounts are always distributed tax-free, while earnings may or may not be taxable. If the Roth account was open for at least five years at the time the account owner died, earnings are distributed tax- and penalty-free. If the earnings are distributed before the account has been open for 5 years, the earnings are taxable, but penalty-free. (The IRS has specific “ordering” rules that determine how much of a distribution consists of contributions or earnings.) If the beneficiary chooses not to take a lump-sum distribution of the Roth IRA, the remaining distribution choices are as follows:

• Spousal transfer - A spouse who is the sole beneficiary of a Roth IRA may transfer the assets into his or her own existing or new Roth IRA and is then regulated by the same rules as if the IRA had been his or hers originally. Distributions of earnings will be taxable until the spouse reaches age 59½ and the account is at least five years old. Under this arrangement, the spouse is not required to take distributions from the Roth IRA while living.

• Inherited IRA, 5-year withdrawal – The assets are transferred into an Inherited IRA held in the beneficiary’s name. Distributions can be spread over time, but all assets must be withdrawn by December 31 of the fifth year after the year in which the account owner died. If distributions are taken during the five-year, post-death period, they will not be taxed provided that the five-year account holding period has been met.

• Inherited IRA, life expectancy withdrawal – Assets are transferred into an Inherited Roth IRA held in the beneficiary’s name. For non-spouse beneficiaries, distributions must begin no later than December 31 of the year following the year of death and are spread over the beneficiary’s single life expectancy. A spouse who is the sole beneficiary has the option of postponing distributions until the decedent would have reached age 70½, if later. If there are multiple beneficiaries, they need to establish separate accounts by December 31 of the year following the year of death in order to use their own single life expectancies. The 10% early withdrawal penalty does not apply.

Trust or Estate as Beneficiary – Special rules apply when the IRA beneficiary is a trust or an estate, and are beyond the scope of this discussion.  

Inherited Personal Residence

Individuals are allowed to exclude gain on the sale of their personal residence if they have owned and used (lived in) the property as their principal residence for two years during the five years immediately prior to its sale. The exclusion is limited to $250,000 ($500,000 for taxpayers filing a joint return where either spouse meets the ownership test and both meet the use test). If the sale of a personal residence, or any other personal-use property, results in a loss, the loss is not deductible. The rules when a personal residence is inherited are as follows:

• Basis and holding period – The basis of the property will be the fair market value at the date of the owner’s death or the alternate valuation date, if it is chosen by the executor or personal representative. The holding period is automatically long-term.  But see "Caution" above for deaths after 2009.

• Use of exclusion by non-spouse beneficiary – If a non-spouse beneficiary inherits what had been the personal residence of the decedent, and then sells the property, generally the home sale gain exclusion will not apply because the beneficiary won’t meet the 2-of-5 years’ ownership and use tests. If the beneficiary moves into the home, and then uses it as his or her own personal residence, the gain exclusion can be claimed if the 2-of-5 years’ tests are met when the home is sold.  (Note: A law change currently on the books and effective for property acquired from a decedent dying during 2010, will entitle a beneficiary to the home sale gain exclusion, determined by taking into account the decedent’s ownership and use.)

• Surviving spouse sells at gain – In most cases, the surviving spouse will inherit the home in which the couple lived. It’s not unusual for the surviving spouse to sell the home within a short period of the decedent’s death, in order to downsize, move closer to family, or go into a retirement facility. In the case of an unmarried individual whose spouse is deceased on the date of the sale of the home, the period the surviving spouse owned and used the property includes the period the deceased spouse owned and used the property before his or her death. This provision benefits a surviving spouse who was only recently married to the decedent who had been the home’s owner or in cases where the decedent had sole title to the home.

A surviving spouse (who is unmarried) qualifies for the up-to-$500,000 exclusion if the home is sold no later than the second anniversary of the spouse’s death and either spouse meets the ownership and use requirements. Absent this rule, the surviving spouse would be limited to an exclusion of $250,000 unless the home was sold in the year of death. However, it would be an unusual circumstance in today’s housing market for even a $250,000 exclusion to be too little to cover the gain for a home sold within two years of the spouse’s death, considering the basis step-up the surviving spouse likely received.

• Loss allowed on sale of inherited home  – A beneficiary who inherits the residence of a decedent, and who sells the property soon thereafter, may sell it for close to the appraised value as of the date of death, which would result in little gain or loss. However, the beneficiary will usually sell the residence through a broker and will have substantial sales costs. These sales costs quite often translate into a large loss on the sale. Normally, the loss upon a sale of a personal residence is not deductible. However, the courts have ruled favorably for beneficiaries selling inherited residences at a loss, allowing a capital loss where the beneficiary immediately attempts to rent or sell the property, or where a beneficiary who was living in the house at the decedent’s death, moves out as soon as other quarters are located. The character of the property has changed from being personal-use property, which it was to the decedent, to investment property of the beneficiary, thus qualifying for a long-term capital loss if sold at a loss.

Depreciable Assets

Depreciation is one of the “events” that affects basis; when a taxpayer has recovered part of his or her investment through a depreciation deduction, the basis must be reduced by the amount of the deduction. However, if you inherit property that the decedent had been depreciating (because he or she had used it in a business or rental activity), the inherited basis of the property may or may not be affected by the prior depreciation that was claimed. If the decedent was the sole owner of the property and died prior to 2010, the inherited basis is the full fair market value at the date of death (or the alternate valuation date, if applicable) – that is, no adjustment is required for the depreciation allowed while the decedent was alive. The inherited basis from decedents dying in 2010 is determined by a more complicated set of rules (see CAUTION 2010 earlier in this article). If the property continues to be used for business or rental purposes, depreciation starts anew based upon the inherited basis.

As explained above under “Beneficiary Tax Basis,” when the decedent had jointly owned the property with another individual, the post-death basis is made up of two parts; the surviving tenant’s part of the original basis plus the value of the portion of the property included in the decedent’s estate. For depreciated property, the combined new basis is also reduced by the depreciation that had been allowed to the surviving tenant; the decedent’s previously claimed depreciation is ignored. For example, Mother and Son invested $60,000 each for a rental property that they owned as joint tenants with the right of survivorship. Up to the date of Mother’s death, depreciation of $20,000 had been claimed. The fair market value at Mother’s date of death was $200,000. The inherited basis of the property is $150,000 ((50% x $120,000) (50% x $200,000) - (50% x $20,000)).

If the beneficiary and the decedent jointly owned the property, and the beneficiary continues to use the property for business or rental purposes after the co-owner’s death, the beneficiary continues depreciating his or her adjusted basis under the same method used in previous years. Depreciation on the part of the basis inherited from the decedent starts anew as of the date of death using the modified accelerated recovery system (MACRS).

A surviving spouse who inherits community property from his or her deceased spouse that was used for business or rental purposes does not reduce the inherited basis by any portion of the depreciation attributable to the period prior to the spouse’s death. The entire new basis (less any land portion if the property is real estate) is depreciable.

Income in Respect of a Decedent

Income a decedent would have received had he or she not died but that was not includible on the decedent’s final income tax return (because it had not been received) is called “income in respect of a decedent” (IRD). Examples of IRD are wages and other compensation for personal services earned but not yet paid as of the date of death; amounts due and owing based on the sale of farm crops or livestock; unpaid interest, investment income, rents and royalties; income from pass-through entities such as partnerships; post-death payments on pre-death installment sales; taxable portion of inherited IRAs; and Roth IRAs to the extent earnings are taxable.

Deductions in Respect of a Decedent – Business expenses, income-producing expenses, interest and taxes for which the decedent was liable but that weren’t properly allowable as a deduction on the decedent’s final income tax return are deductible, when paid, by the beneficiary of the property if the estate wasn’t liable for the obligation.

Estate Tax Deduction Mitigates Double Taxation - Income in respect of a decedent is included in the decedent’s estate tax return and then also becomes taxable for income tax purposes when it is later collected by the estate or beneficiary. If estate tax was paid on this income, an income tax deduction is allowed to the IRD recipient for the estate tax paid on the income. The deduction is claimed only for the same tax year in which the IRD must be included in the recipient’s income. An individual claims the deduction as a miscellaneous itemized deduction, not subject to the 2% of AGI limit, and it is also allowed as a deduction for alternative minimum tax purposes.  If you are a beneficiary who is required to include IRD in your income, you should be sure to obtain a copy of the estate’s Form 706 from the executor so that you or your tax return preparer will have all of the information necessary to calculate the estate tax deduction.

Estate’s Income Tax Reporting

During the period from an individual’s date of death until that individual’s assets have all been passed into the hands of the heirs and beneficiaries, income earned by those assets must be accounted for by the estate (or trust if so established by the decedent’s will or a trust agreement).  The estate is a taxable entity separate from the decedent; it comes into existence upon the death of the decedent and lasts until all of the assets have been distributed to the heirs and beneficiaries.

Like an individual, an estate must file an annual income tax return (Form 1041) if its income exceeds a filing threshold amount (currently $600).  The executor has the option of using a month ending other than December 31 as the end of the estate’s tax year. (Generally, trust returns must have a December 31 year-end, but under some circumstances the trustee can elect to have the trust treated like an estate and use other than a calendar year-end.)

Who Pays the Income Tax? The income tax liability of an estate attaches to the assets of the estate. If the income is distributed, or must be distributed, during the current tax year, the income is reportable by each beneficiary on his or her individual income tax return. But if the income does not have to be distributed, and is not distributed but is instead retained by the estate, the income tax on the income is payable by the estate. Should the income be distributed later without the tax having been paid, the beneficiary can be liable for the tax to the extent of the value of the estate’s assets received. The estate’s income is taxed either to the estate or the beneficiary, but not both. Other than in the final year of the estate, when the beneficiaries must report any taxable income, it is generally at the executor’s option whether the income is distributed to the beneficiaries. Recipients of “specific bequests” generally do not have to pay tax on any portion of the income earned by the estate. These concepts are illustrated in the following example:

Example: Father died on June 30, 2008. Per his will, Cousin is to receive $10,000, and after paying any estate tax liability, funeral expenses, last-illness expenses, and other debts, his Daughter and Son each are to receive 50% of the remaining estate. Father’s estate consisted of savings accounts and stocks (no real estate). The executor of the estate selected a year-end of January 31, 2009. During the period from Father’s death through January 2009, the assets of the estate earned $5,000 of interest income and $2,000 of stock dividends. Neither this income nor any of the estate’s assets were distributed to Cousin, Daughter or Son by January 31. The executor must file a Form 1041 that reports the $7,000 of income and will pay the tax on that income from the assets of the estate. After getting the probate court’s approval to distribute the assets of the estate, the executor does so on July 31, 2009. The interest and dividend income earned from February 1 through the date of distribution is $6,000. Since the estate’s assets, and income earned since Father’s death, are passed on to Daughter and Son, they would each be responsible to include $3,000 of income on their individual returns. Cousin receives $10,000 from the estate, but does not receive any of the income, and thus pays no tax on it. The executor will file a final Form 1041 Income Tax Return for the estate for the period February 1, 2009 through July 31, 2009. This return will show that the income has been distributed to the beneficiaries and is not taxable to the estate.

Commonly, the executor will pay attorney fees and other expenses during the last tax year of the estate. If these expenses have not already been claimed on the Estate Tax Return, they can be used to offset the income earned during the same period. If the expenses exceed the income, the excess deduction is passed on to the beneficiaries to use on their income tax returns. In that case, none of the income earned during the final reporting period is taxable to the beneficiaries. The final-year excess estate deductions are deductible on each beneficiary’s individual income tax return as a miscellaneous itemized deduction subject to the 2%-of-AGI limitation.

Form 1041, Schedule K-1 – When distributions are made to the beneficiaries, the amount of income or deductions reportable by each beneficiary on their own Form 1040 is shown on Schedule K-1 of the estate’s income tax return, Form 1041. The executor is required to provide each beneficiary a copy of his or her Schedule K-1 by the date the Form 1041 is filed. For the K-1s to be accurately completed, each beneficiary is required to provide their taxpayer identification number (Social Security number) to the executor. In the example above, Daughter and Son would each receive a K-1 from the executor, but no K-1 would be prepared for Cousin.

Donating Decedent’s Property to Charity

Generally, an individual will leave instructions to the estate executor in his or her will as to the desired disposition of personal property owned by the decedent at death. This may include identifying specific items to go to specific individuals, or that all of the decedent’s personal property is to be divided amongst the heirs, or that it should be disposed of as seen fit by the executor. Often, the property ends up being donated to a charity.  These post-death donations are not deductible on the decedent’s final income tax return, and do not qualify to be deducted on the estate tax return unless the decedent’s will identified the charity to which the donation was to be made.

If you received personal property from a decedent’s estate and then donated it to a qualified charitable organization, you may be able to claim a charitable deduction as an itemized deduction on your income tax return.  The value (basis) of the contributed property for the purpose of calculating the deduction will be the fair market value of the property as of the decedent’s date of death (or alternate valuation date, if applicable).  Caution: In the case of decedents dying in 2010 the value may not be the FMV and instead may be some other value as determined in the estate under complicated rules that apply to 2010 (See CAUTION 2010 earlier in this article). The executor, when making an inventory of the decedent’s assets, should also have determined the inherited value of the personal property, so you may need to confer with the executor to obtain this information. The IRS has stringent rules related to non-cash donations, which are summarized next.

Deductions of Less Than $250 – If you claim a non-cash contribution for donation to a qualified organization of property such as used clothing or furniture with a value less than $250, you must get and keep a receipt from the charitable organization showing:

1.  The name of the charitable organization,
2.  The date and location of the charitable contribution, and
3.  A reasonably detailed description of the property that was donated.

However, you are not required to have a receipt where it is impractical to get one, such as when the property was left at a charity’s unattended drop site.

Deductions of At Least $250 But Not More Than $500 - If you claim a deduction of at least $250 but not more than $500 for a non-cash charitable contribution, you must have and keep an acknowledgment of the contribution from the qualified organization. If the contributions were made by more than one contribution of $250 or more, you must have either a separate acknowledgment for each or one acknowledgment that shows the total contribution.  The acknowledgment(s) must be written and include:

1.  The name of the charitable organization,
2.  The date and location of the charitable contribution,
3.  A reasonably detailed description (but not necessarily the value) of any property contributed,
4.   Whether or not the qualified organization gave you any goods or services as a result of the contribution (other than certain token items and membership benefits), and
5.   If goods and or services were provided to you, the acknowledgement must include a description and good faith estimate of the value of those goods or services.  If the only benefit received was an intangible religious benefit (such as admission to a religious ceremony), that generally is not sold in a commercial transaction outside the donative context, the acknowledgment must say so and does not need to describe or estimate the value of the benefit.

Deductions Over $500 But Not Over $5,000 - If you claim a deduction over $500 but not over $5,000 for a non-cash charitable contribution, you must have the same acknowledgement and written records as for contributions of at least $250 but not more than $500 described above.   In addition, the records must also include:

o How the property was obtained.  For example, by purchase, gift, bequest, inheritance or exchange.
o The approximate date the property was obtained or, if created, produced, or manufactured by the taxpayer, the approximate date the property was substantially completed. (For property acquired from a decedent, this is the date of death, not the date that you actually gained physical control of the property.)
o The cost or other basis, and any adjustments to the basis, of property held less than 12 months and, if available, the cost or other basis of property held 12 months or more. (Generally, this will be the inherited value of the property at the date of death of the decedent, unless the alternate valuation date is used for estate tax purposes. If you have made improvements to the property, increase the inherited basis by your costs.)

Deductions Over $5,000 –Special rules apply related to contributions over $5,000; please confer with your tax advisor regarding the documentation requirements for the particular contribution before making the contribution.

With the exception of vehicle contributions (see below), charitable gift acknowledgements must be obtained before the earlier of the date you file your return for the year you make the contribution, or the due date, including extensions, for filing your return.

Additional Rules - Besides the recordkeeping and reporting rules noted above, the IRS has additional requirements when used vehicles, clothing or household items are donated:

• Vehicle Donations - The deduction for motor vehicles for which the claimed value exceeds $500 is dependent on the charity’s use of the vehicle. If the charity sells the vehicle, generally the donor’s charitable deduction is limited to the amount of the gross proceeds from the charity’s sale.

When the deduction claimed for a donated vehicle (car, boat, plane) exceeds $500, IRS Form 1098-C (or other statement containing the same information as Form 1098-C) furnished by the charitable organization must be attached to the filed tax return.  Without the 1098-C or other statement, no deduction is allowed. When the charity sells the vehicle, the Form 1098-C (or other statement) must be obtained within 30 days of the sale of the vehicle. Otherwise, the Form 1098-C (or other statement) must be obtained within 30 days of the donation.

• Clothing and Household Goods Contributions - No deduction is allowed for a charitable contribution of clothing or household items unless the clothing or household item is in:
o Good used condition, or
o Better.

In addition, the IRS may deny a deduction for any item with minimal monetary value, such as used socks or undergarments. A deduction may be allowed for a charitable contribution of an item of clothing or a household item not in good used condition or better if the amount claimed for the item is:
o More than $500, and
o You include with your return a qualified appraisal with respect to the property.

• Household Items - Includes furniture, furnishings, electronics, appliances, linens, and other similar items.  Food, paintings, antiques, and other objects of art, jewelry and gems, and collections are excluded from the provision.


Under tax law, a taxpayer is required to treat debt forgiveness as income on their tax return. Let’s say a taxpayer owes $500,000 on the home mortgage. The home is foreclosed upon; after the sale, the lender only recovers $450,000 of the debt. The taxpayer would be required to include the $50,000 difference as income unless they had filed Title 11 bankruptcy or qualified for the insolvent taxpayer exclusion. This is also the case if a taxpayer negotiates a reduced mortgage or a voluntary reconveyance with the lender instead of suffering a foreclosure.

Concerned with the decline of real estate values and the impact on the mortgage industry and homeowners, Congress passed the Mortgage Forgiveness Debt Relief Act of 2007 which allows taxpayers to exclude up to $2 million ($1 million for MS) of qualified principal residence acquisition debt on the taxpayer’s qualified principal residence discharged on or after January 1, 2007 and before January 1, 2010. The basis of the taxpayer’s home is reduced by the excluded amount, but not below zero. In some circumstances, this could result in a higher gain on the home sale, which may or may not be fully excludable under the home sale exclusion rules.

Caution – The exclusion does not apply to a taxpayer’s designated 2nd (vacation) residence.

Caution – The exclusion only applies to the discharge of qualified principal residence acquisition debt. Thus, equity debt is not included as part of the exclusion. Acquisition indebtedness of a principal residence is indebtedness incurred in the acquisition, construction, or substantial improvement of an individual’s principal residence that is secured by the residence. It includes refinancing of debt to the extent the amount of the refinancing doesn’t exceed the amount of the refinanced indebtedness.

If any loan is discharged, in whole or in part, and only part of the loan is qualified principal residence indebtedness, the mortgage forgiveness exclusion applies only to so much of the amount discharged as exceeds the amount of the loan (as determined immediately before the discharge) which is not qualified principal residence indebtedness. Thus, where there is a mixed loan (part acquisition and part equity debt), the sequence of forgiveness is treated as applying to the acquisition debt first and then to the equity debt.

The exclusion doesn’t apply to the discharge of a loan:

  • If the discharge is on account of services performed for the lender or any other factor not directly related to a decline in the value of the residence or to the taxpayer’s financial condition.
  • Of a taxpayer in a Title 11 bankruptcy.

An insolvent taxpayer (other than one in a Title 11 bankruptcy) can elect to have the mortgage forgiveness exclusion not apply and can instead rely on the exclusion for insolvent taxpayers. Thus, where a taxpayer has significantly tapped the equity in the home, and has a significant amount of debt discharge that does not qualify for the exclusion, it may be to their advantage to forgo the mortgage relief exclusion and instead use the insolvent taxpayer exclusion.

If you are unfortunate to find yourself in these circumstances, please call this office for a consultation to see how this new law will affect you.





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