When is an estate income tax return required?

Perhaps the easiest way to assess this is to ask if this was your own personal financial affairs would you have an obligation to lodge an income tax return bearing in mind that the deceased has fundamentally the same requirements to lodge a return as any individual taxpayer?

Current at 1 November 2021

When is an estate income tax return required?

Perhaps the easiest way to assess this is to ask if this was your own personal financial affairs would you have an obligation to lodge an income tax return bearing in mind that the deceased has fundamentally the same requirements to lodge a return as any individual taxpayer?

Current at 1 November 2021

Both a date of death and estate return are eligible for the same tax free threshold (currently $18,200). It should be noted that whilst an estate return has access to this tax free threshold, it does lose this after a period of three years, but still has access to progressive marginal tax rates.

The fundamental questions are really as follows:

  • Did the deceased or the estate pay or have tax withheld?
  • Is the taxable income above $18,200?
  • Was the taxpayer conducting a business?

The first question is an important one. If the taxpayer has either paid or had tax withheld and has income above the tax free threshold, the estate could be eligible for a tax refund or potentially have a tax liability. Generally, if a taxpayer has paid tax in any form, then it is a fair indication that the executor may have an income tax obligation to consider.

Importantly, both the deceased and estate are treated by the Income Tax Assessment Act (ITAA) as separate taxpayers and accordingly both are entitled to the full tax free threshold in the year of death. The Act does not pro rata this entitlement, so both the returns would be eligible to the full $18,200 tax free threshold. Moreover, that estate returns are specifically excluded from the Medicare levy of 1.5% on any undistributed income. s. 215(s) of ITAA 1936.

A taxpayer who was in business has an automatic obligation to lodge a tax return regardless of the income levels of the business, and this would include if the business was trading at a loss. It is important to note that this obligation does not include business income generated from either a private trust or company, but rather relates to business income generated from trading as either a sole trader or as a partner of a partnership. Trust distributions and private company dividends would however be included when assessing if a taxpayer had an obligation to lodge an income tax return.

Date of death return

This return is required to be prepared for the period commencing at the beginning of the taxpayer’s financial year (normally 1st July) to their respective date of death. Any income earned during this period should be reviewed to determine if the taxpayer has any tax obligations, i.e. their income for the period is greater than $18,200. If the legal personal presentative (LPR) determines that there is no obligation or need to lodge an income tax return, then they should lodge a nonlodgement advice with the Australian Taxation Office (ATO). Both this form and the date of death return (sometimes referred to as the final return) are the medium to advise the ATO that the taxpayer is now deceased and that no further returns are required. The LPR should also ensure that they determine any outstanding tax obligations the deceased had at their date of death, and appropriately address these at this time.

Deceased estate return

This return aligns itself with the administration period of the estate and as noted above is the responsibility of the LPR, who must determine if the estate has or will have any tax obligations, and then ensure that these obligations are met. If the estate does have tax obligations, then the LPR must apply for a separate tax file number (TFN) to that of the deceased. There is no need to lodge an estate tax return for the income year if all of the following apply:

  • The deceased person died less than three years before the end of the income year.
  • The net income of the deceased estate is less than the individual tax-free threshold.
  • The deceased estate received no income from capital gains or franked dividends.
  • The deceased estate received no income from which tax has been withheld.
  • The deceased estate did not carry on a business.
  • No beneficiary is presently entitled to a share of the income of the deceased estate.
  • All beneficiaries of the trust estate are Australian residents.

The ITAA provides for a deceased estate to be taxed using standard adult marginal rates for a period up to three years. The Commissioner does however have the ability to remove this concession if it’s believed that the estate administration is being unnecessarily delayed; in particular to take advantage of lower marginal rates than beneficiaries may be subject to within their own names.

Should I lodge anyway?

There are two schools of thought when it comes deciding to lodge an income tax return, and neither is technically incorrect, so this should be decided on a case by case scenario.

In Australia income tax is assessed on a selfassessment basis, meaning the Commissioner ordinarily accepts at face value the details of the return lodged, but does have the right to undertake an audit on any return. This right to undertake an audit is limited by the ITAA in subsection 170(1) to either a 2 year or 4 year period.

This means that as such, once a return is lodged, the clock physically starts ticking and when this time period elapses, any errors or unintended omissions within the return are essentially quarantined. The two year amendment period generally relates to taxpayers with more basic affairs such as salary and wages, bank interest and dividends. Whereas in situations where a taxpayer is conducting a business, holds a rental property or is a beneficiary of trust income, then this audit period will be extended to 4 years.

Given the uncertainty of the LPR’s personal responsibility of income tax after an estate has been distributed, we see a number of executors opt to avail themselves of the protection of this quarantined period by physically lodging a return even when the income is below the tax free threshold. It would be fair to say that from our observations the industry would appear to be equally split between lodging and not lodging in these cases.

There is an argument that the estate should not be unnecessarily burdened with the cost of preparing unnecessary tax returns, but equally an argument that it is hard to recover funds from beneficiaries to meet subsequent tax debts after the estate has been distributed.

Furthermore, the ATO has released Practical Compliance Guideline (PCG 2018/4) – Income tax – liability of a LPR of a deceased person. The guideline provides the LPR an idea of the ATO’s position on outstanding returns and tax liabilities of a deceased taxpayer and when the LPR can distribute without being made personally liable for outstanding tax debts. More information can be found on our website.

Finally, it should be noted, that in the case of fraud or tax evasion the Commissioner has an unlimited time frame in which to amend returns.

It is worth noting that taxpayers in receipt of fully franked dividends could be eligible for a refund of the associated franking credits even if their income did not reach the tax-free threshold. We have seen this at times missed by both the taxpayer and subsequently the LPR. It can easily accumulate in size to thousands of dollars of missed tax refunds.

 

CASE STUDY

The below actual example highlights how a relatively straight forward matter can soon result in a number of tax obligations.

John was a war veteran and died in January 2016 at the age of 77. His wife had died some 10 years earlier. At his date of death his assets were:

  • An apartment in Bondi, Sydney valued at $2.1M with beach front views where he lived until his death.
  • Shares with the four big banks valued over $1.1M.
  • Cash of $10,000

John also received a war pension which is tax exempt and had ceased lodging tax returns 10 years earlier has he had technically determined that he no longer had an obligation to lodge tax returns as his income was below the tax free threshold for senior Australians. As a result, John had lodged his final tax return 10 years ago.

In his Will, John had appointed his war buddy Tom as his executor and had left his estate to be divided equally between his daughter Jane who now lived in Zurich and Legacy Australia; a registered deductible gift recipient. Jane has already indicated that she would like to take an in-specie transfer of shares and cash, whilst Legacy Australia had indicated a preference for cash.

After consulting with advisers, Tom decided to:

  • Sell the apartment
  • Transfer 50% of the bank shares to Jane
  • Sell the other 50% of the shares

After the assets all transferred or sold, Tom decided it might be prudent to call the ATO to assess his limited understanding of his tax obligations as an executor. The ATO correctly explained that returns would be required for the estate as assets have been sold and that he should find an accountant specialising in deceased estates to assist him.

Upon contacting BNR, and our team undertaking a review of the estate, it was confirmed that tax returns would be needed for both the individual and the estate.

Our review resulted in BNR identifying the following tax issues and obligations:

  • If the deceased had lodged tax returns in the last 10 years he would have received franking credit refunds of circa $3,000 per year (A $30,000 plus windfall for the estate).
  • A capital gains tax (CGT) event K3 had been triggered on the transfer of the bank shares to Jane which would result in $210,000 payable to the ATO on assessment. This would be required to be reported within the deceased’s date of death tax return.
  • There was now a potential reportable capital gains tax liability on the sale of the remaining shares that have been sold to transfer funds to Legacy Australia, unless it was possible to demonstrate that Legacy Australia could be made presently entitled to these taxable gains. Either way, the gain would need to be reported within the estate’s tax return.
  • That there were now capital gains tax implications on the sale of the Bondi property as it was settled more than 2 years post John’s death unless an extension of the main residence exemption can be obtained. (It took more than two years after John’s death to sell and settle the property as Tom was hospitalised for a few months during the administration process.)
  • Estate tax returns would be required from date of death to the completion of the estate administration.
Download our quick reference guide on whether an estate tax return is required to be lodged in your situation HERE

 
 
 

Feel free to contact our team should you want to discuss this topic further and potentially have clients who may be in this situation.

 

 

This publication is not intended to be and should not be used as a substitute for taking taxation advice in any specific situation. The information in this publication may be subject to change as taxation, superannuation and related laws and practices alter frequently and without warning.  Neither BNR Partners Pty Ltd, our employees or agents are responsible for any errors or omissions or any actions taken or not taken on the basis of this publication.