Oct 02, 2023
We have all heard a reference to the famous quote made by Benjamin Franklin about death and taxes. The accurate quote is: “Our new Constitution is now established, and has an appearance that promises permanency; but in this world, nothing can be said to be certain, except death and taxes.” Even though he made this statement in a letter in November of 1789, it still rings true today. I doubt he could have ever imagined how much we are taxed today: income tax, Social Security and Medicare tax, sales tax, property tax, gift tax, inheritance tax,… the list goes on and on.
So, what happens when someone passes away and there is still a tax bill outstanding in their name? I thought a lot about this topic this past summer while tending to a parent in their final stages of life. Though she did not have a tax debt that needed to be addressed, it is something that we will inevitably face when dealing with a family member or a client who is left picking up the pieces after a family member’s passing. Although this blog post is not intended to be all-encompassing or to provide all the little details that could have an impact, this is a great starting point as a general guide to how a tax debt needs to be addressed after someone passes. For the purposes of simplicity (and because all States have their own rules and procedures, sometimes seemingly dependent on the Chinese horoscope symbol for that particular year, if the aliens have landed yet, etc.), we will use the IRS as our guide point for this blog.
First and foremost, the type of taxes owed dictates what happens to the debt following the responsible taxpayer’s death. If it is for income-related taxes, then their marital status, how they filed their annual return, and whether or not they lived in a community property state all come into play. For a business-related tax debt, the surviving spouse’s direct exposure to the tax debt depends on his/her involvement with the business, what type of business entity it was, and if they lived in a community property state during the accrual.
For income tax, the debt will always flow through to the surviving spouse if they filed their annual tax returns as married filing jointly. If they filed married filing separately and lived in a community property state, it’s the same situation with a bit of a tweak: the surviving spouse is responsible for the deceased spouse’s tax debts only if they were accrued during the marriage. If the couple always filed married filing separately and did not reside in a community property state, the surviving spouse is not directly responsible for the deceased spouse’s income tax debt. However, and this is written with extra emphasis on the “however”, the deceased taxpayer’s estate is responsible for addressing any remaining tax debts at the time of their passing.
To help explain, let’s use the example of Michael and Megan Hutchins, who lived in Scottsdale, Arizona (a community property state). Michael worked as an engineer, making a fantastic wage in his later years, and Megan maintained a part-time job at a clothing boutique. Michael and Megan each had a life insurance policy that would pay the surviving spouse $450,000 upon death. Because Megan liked to shop and wanted to vacation more, Michael adjusted his withholding to reduce the amount of income taxes withheld from his pay to compensate for the lavish spending, but in an effort to protect Megan from his tax bill, he began filing Married filing Separately starting with their 2018 tax return. Between tax years 2018 and 2022, Michael accrued a tax balance owed to the IRS in the amount of $165,000. In April of 2023, Michael died suddenly from a heart attack. Two factors here impact the handling of the tax debt: Megan and Michael were married and lived in a community property state during the years the taxes were accrued. Though Michael filed his annual tax return separately from Megan, she is still responsible for his debt. The proceeds from the life insurance policy would have to be used to address the IRS tax bill. If there wasn’t a life insurance policy in place, Megan would have to address the tax debt in some manner, whether through an Installment Agreement, Currently Not-Collectible, Offer in Compromise, by liquidating an asset, or through filing Bankruptcy.
For business taxes, more asterisks come into play. First, we have to look at the type of entity the business was. If it’s a sole proprietorship, the entity and the individual are the same. Following the taxpayer’s passing, the examples provided above regarding personal income tax are a general guideline to follow. For an LLC, Partnership, S-Corporation, or C-Corporation tax debt that remains owed, asterisks abound, and the type of taxes owed will be the driving factor.
In the end, know that their tax bill doesn’t magically disappear just because someone passes. It must be addressed, whether with payment or by proving the taxpayer’s estate doesn’t have the means to address the debt. If you or your client find yourself in a battle with the IRS over a deceased taxpayer’s account, reach out to the team at Golden Lion Tax Solutions. With over 24 years of handling tax debt situations like these, we have the first-hand knowledge to know what needs to happen to resolve the situation.
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