Although the increased estate tax exemption has minimized the number of taxable estates, numerous tax issues still must be addressed when a taxpayer dies. One of those is dealing with carry-overs that the taxpayer or spouse may have had at the time of his or her death. These carryovers can include net operating losses (NOLs), passive losses, charitable contributions, and myriad other deductions or credits that have not been used in prior years.
Generally, carryovers can be used on the decedent's final income tax return but are lost thereafter. For a single taxpayer, this is fairly straightforward. It is more complicated when the decedent is married and files jointly. When the surviving spouse files a joint return with the decedent for the year of his or her death, the full amount of carryovers can still be used in the year of death, even if they are used to offset income of the surviving spouse that was generated after the death. However, after the year of death, the carryovers must be examined carefully to determine which carryover amounts, if any, belonged to the decedent, because any amounts attributable to the decedent are lost and cannot be transferred to the surviving spouse.
For a couple who have filed a joint return for many years, there could be several types of carryovers coming into the year in which one spouse dies. Each carryover must be allocated to each spouse.
What can a practitioner do not only to ensure that carryovers are properly allocated at death, but also to help surviving spouses best use tax carryovers that would otherwise expire? Some possible suggestions include:
- When preparing tax returns for married couples, always trace items of deduction, loss, and credit to each spouse. Be careful to note which spouse owns which capital assets and passive activities.
- If a couple are new clients, and there are carryovers from prior years, consult with the clients and determine the amount of carryovers attributable to each spouse. In addition to asking for a copy of the immediate prior-year tax return for new clients, consider asking for several years of returns to be able to track the carryovers to the years generated. It is always much easier to get those return copies when the couple first become clients, as opposed to years later when there is a death.
- Advise the surviving spouse to consider ways he or she could use the deceased spouse's carry-overs on the joint return for the year of death. The surviving spouse could sell his or her own properties at a gain to use the deceased spouse's capital loss carryovers that would otherwise expire, or the surviving spouse could take an IRA distribution and offset that income with the deceased spouse's NOL carryovers. Work with the surviving spouse to achieve the best tax results before the end of the calendar year in which the decedent died, since the final joint return will include all income for both spouses for the entire year, and the decedent's carryovers are available on that return.
- Use this opportunity to discuss estate planning for the surviving spouse. While the widow or widower may not need to make major financial decisions immediately upon the death of a spouse, if income tax issues need to be addressed, the CPA is typically in a good position to cover these with the surviving spouse.
Whether the death of a spouse is sudden or follows a long illness, it can be a heartbreaking time. Being aware of the rules for carryovers, knowing how they affect taxpayers, and being prepared to discuss potential tax-saving opportunities may allow the CPA to make this difficult time a bit easier for the surviving spouse and other family members.
For a detailed discussion of the issues in this area, see "Tax Practice & Procedures: Till Death Do Us Part: Dealing With Carryovers When a Spouse Dies," by Jan F. Lewis, CPA, in the January 2017 issue of The Tax Adviser.
—Alistair M. Nevius, editor-in-chief, The Tax Adviser
The Tax Adviser is the AICPA's monthly journal of tax planning, trends, and techniques.
Also in the January issue:
- An analysis of outbound transfers of intangible property.
- A look at how to document D reorganizations with a split-off.
- A discussion of how changes in LB&I could affect midmarket taxpayers.
AICPA members can subscribe to The Tax Adviser for a discounted price of $85 per year. Tax Section members can subscribe for a discounted price of $30 per year.