CPD: Deceased estates and tax
Everyone knows the famous Benjamin Franklin quote about death and taxes, but not everyone is aware that tax obligations continue after death. This article, proudly sponsored by Allianz Retire+, examines these obligations and other tax matters that affect a deceased estate.
In the last article in this series, we examined Estate planning and tax and the measures clients can consider when preparing their estate, particularly as it relates to minimising tax for beneficiaries. However, while it might be expected that tax obligations effectively end with death, that is not the case. And, while Australia has not had a formal inheritance tax (in the form of death duties) since 1979, bequests are not always received tax free.
Death and tax – obligations
The ATO works on the assumption that a deceased estate will continue to earn income after death. This income might arise from interest, dividends or rent from property investments. It’s a requirement that any tax obligations are finalised before the assets of an estate are distributed.
If a client is administering an estate, they need to understand their obligations under tax law. These are to[1]:
- notify the ATO of the death so it ceases any correspondence re tax matters
- determine whether they need a grant of probate or letters of administration.
One of these court-issued documents is required to be considered the authorised legal personal representative (LPR) by the ATO, and thereby be granted full authority to manage the deceased’s tax affairs and have unrestricted access to ATO-held information and assets of the estate.
One of these documents is generally required to manage other aspects of a deceased estate; this may vary according to law in the relevant state or territory.
- The ATO must be notified as to who is managing the estate; this is done by submitting an official notification of death. The ATO will add the LPR’s name to the estate’s records.
- If the deceased person’s tax affairs included running a business, business tax obligations must be managed.
If the deceased person was a sole trader or in a partnership, a final business activity statement (BAS) for the last tax period may need to be lodged. This is usually the quarter in which the person died and the period ends the day before their death. Any outstanding BAS will need to be lodged and tax paid.
Goods and services tax (GST) and capital gains tax (CGT) may apply to the sale of any assets used in the business.
- check to see whether a final tax return for the deceased needs to be lodged. This is called a ‘date of death’ tax return and covers the income year in which the person died, up to the date of death.
A date of death tax return must be lodged if any of the following applied to the deceased in the income year in which they died:
- they had tax withheld from their income, including from interest, dividends or rent
- their taxable income was above the tax-free threshold
- they lodged tax returns in the income years before their death or have outstanding tax returns.
The deceased’s date of death tax return should include:
- any salary earned up to the date of death
- investment income earned up to the date of death
- capital gains where the agreement to sell was made prior to death
- any taxable superannuation income received up to the date of death.
Any outstanding tax returns must also be lodged and where applicable, tax paid to the ATO.
If a date of death tax return is not required, a non-lodgement advice form must be completed and provided to the ATO.
- Tax returns for the deceased estate, called a trust tax return, must be lodged for each year. This traverses the income year in which the individual died, through to the year the estate is finalised, and assets distributed to beneficiaries. The first income year of a deceased estate starts the day after the date of death and ends on the following 30 June.
The trust tax return should include:
- any salary earned after death
- investment income after death; this should include income earned from assets such as dividends, interest or rent
- capital gains on assets sold by the estate
- deductions for expenses incurred by the estate related to earning income.
The deceased estate is deemed to be a separate entity to the deceased individual, hence the need for separate tax returns.
You can lodge a trust tax return even if it is not required. For example, your client may wish to lodge a return to claim franking credits on dividends paid to the estate.
A note on capital gains and losses; capital gains are still taxable after death, but capital losses die with the deceased. In the event a client’s death is anticipated, a strategy to sell assets carrying unrealised gains to use capital losses being carried by the client might be considered.
Death and the family home
Although Australia officially abolished death duties in 1979, the family home is a substantial asset in most estates and one that may attract capital gains tax (CGT). Its tax treatment is dependent on several factors, the most important being whether the home is a pre-CGT asset (bought prior to 20 September 1985) or acquired after that date. Other impacts arise from whether the home is covered – in full or in part – by the main residence CGT exemption, and how the title is held.
If the deceased purchased the property before 20 September 1985 and is inherited after this date, the property is valued at its market value at the date of death of the property owner and beneficiaries generally have two years to sell the property to qualify for a CGT exemption.
If the home is a post-CGT asset, the beneficiaries inherit the property at market value at the date of death if it is covered by the main residence exemption at the time of death. The main residence CGT exemption applies if[2]:
- the home was the deceased’s main residence before death and was not being used to produce income, and
- the home was sold and settled within two years of the person’s death (although this timeframe can sometimes be extended at the discretion of the ATO), or
- from the deceased’s death until disposal, the dwelling is not used to produce income and is the main residence of one or more of:
- the spouse of the deceased immediately before the deceased’s death,
- an individual who had a right to occupy the dwelling under the deceased’s will, and
- a beneficiary, if disposing of the dwelling as a beneficiary.
If the property is not or only partially exempt from CGT, the beneficiary needs to know its cost base to determine the capital gain. If the property is partially exempt from CGT, the beneficiary needs determine the proportion of the property that is exempt.
In the case where land was purchased before 19 September 1985, but a home built on the property after that date, the property is treated as two separate assets; the land is treated as a pre-CGT asset and the home as a post-CGT asset.
Ownership through company or trust
If a client owns (or inherits) a home through a company or trust, death does not affect the ownership of the home – the entity that owns the home has not died. If the deceased holds units in a trust or shares in a company that owns the home, the estate has to manage the ownership of those units or shares. Where clients have a company or trust, their estate planning should include the transfer of those units or shares.
It’s important to know that holding the family home in a company or trust will prevent your clients’ estate from benefiting from the main residence CGT exemption.
Death and super
Like the family home, superannuation is often a major estate asset…however, super death benefits don’t automatically form part of a deceased member’s estate. This is because super isn’t considered to be a personal asset that’s owned in the client’s own name; it’s held in trust by the super fund’s trustees.
In the majority of cases, the super fund’s trustees pay the death benefits directly to the deceased’s dependants or beneficiaries as defined in a binding death benefit nomination. In this case, those death benefits do not form part of the estate.
In some cases, the fund trustees may pay the death benefits, in full or part, to the estate’s executor, in which case the superannuation death benefits do form part of the estate and are distributed in accordance with the deceased’s will. Clients may make a valid binding nomination in favour of the estate rather than individual/s if they wish their super death benefit to form part of their total estate.
The distribution of super death benefits depend on a number of factors: the terms of the fund’s trust deed, applicable legislation and any valid beneficiary nomination made by the deceased.
Superannuation lump sum death benefits are tax free if paid to a “death benefits dependant” for tax purposes. A “death benefits dependant” is defined as:
- the deceased persons current or ex-spouse or de facto spouse
- the deceased persons child aged under 18 years of age
- any other person with whom the deceased had interdependency relationship.
Any other person who the deceased person had an interdependency relationship with just before they died, or anyone dependent on the deceased person just before their death is also considered to be a “death benefits dependant”.
The definition of a “death benefits dependant” under taxation law (in other words, who can receive a tax free death benefit) is slightly different to the definition of a “dependant” under superannuation law.
If superannuation death benefits are paid directly by the super fund trustee to a dependent who is not considered a death benefits dependent (e.g. a child over 18 who was not financially dependent on the deceased at the time of death), the trustee is responsible for calculating and withholding any applicable superannuation death benefits tax from the payment.
The tax on a super death benefit depends on:
- whether the recipient was a dependant of the deceased under tax law
- whether it is paid as a lump sum or income stream
- whether the super is tax-free or taxable
- the recipient’s age and the age of the deceased person when they died (this is relevant to income streams).
Tax is only paid on the taxable component of the benefit; money contributed as concessional contributions and fund earnings. Non-concessional contributions comprise the ‘tax-free’ component. If tax does apply, it is levied at a maximum of 17% (15% plus Medicare levy). If the deceased was under 65 at the time of their death, some of the taxable component may be taxed at a rate up to 32% (including Medicare levy).
In the situation where death benefits are paid to the legal personal representative (such as the executor), the trustee does not deduct tax. Instead, they provide the estate’s representative with a statement detailing the taxable components of the payment. It is then the responsibility of the legal representative to pay any super death benefits tax from the estate before it is distributed.
If superannuation death benefits are paid to the legal personal representative and then to a death benefits dependant, no tax will be payable.
Self-Managed Super Funds
For those clients with an SMSF, consideration needs to be given to who will control their SMSF when they die. This is because the person in control of the SMSF may, subject to any binding death benefit nomination, have the ability to deal with the deceased member’s death benefits as they choose.
When creating an estate plan for clients with an SMSF, it is important to:
- ensure the estate plan transfers control of the SMSF, including the power to pay death benefits, in line with the client’s wishes
- consider whether a binding death benefit nomination should be made.
When an SMSF member dies, the SMSF generally pays a death benefit to a dependant or other beneficiary of the deceased.
If the death benefit is paid as a lump sum to a death benefits dependant of the deceased, it’s tax free and not considered assessable or exempt income. The SMSF doesn’t withhold tax from the payment and the recipient don’t include it in their income tax return.
If the death benefit is paid as an income stream and is paid to a non-dependent or the trustee of a deceased estate, there may be tax to pay. The SMSF will need to determine the taxed and untaxed elements of the benefit, calculate the applicable tax and, if appropriate, withhold tax from payments.
Bequests and tax
While there may be no inheritance taxes in Australia, beneficiaries may have tax obligations for the assets they inherit. Capital gains tax may apply if a client disposes of an asset inherited from a deceased estate (but not the family home if disposed of within two years).
Income producing assets, such as cash, shares and property attract no tax on the value of the asset itself, only on the income derived from it. If a client inherits shares, they will be required to pay tax on the dividends received. Similarly, inherited property attracts income tax on rental income and cash on interest income. Tax payable is generally calculated from the date of death of the person bequeathing the asset.
Dealing with a deceased estate is much more than simply dividing up assets. Clients preparing their estate – or preparing to administer an estate – need to be aware of the myriad of obligations that follow death. A sound estate plan, with thought given to the administration of that asset and taking measures to minimise the tax liabilities for beneficiaries can smooth the process for intergenerational wealth transfer. The Productivity Commission’s 2021 report highlights an expected A$3.5 trillion intergenerational asset transfer in Australia by 2050, making estate and related tax planning an integral part of the advice process.
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CPD Quiz
The following CPD quiz is accredited by the FAAA at 0.5 hour.
Legislated CPD Area: Tax (Financial) Advice (0.5 hrs)
ASIC Knowledge Requirements: Estate Planning (0.5 hrs)
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Notes:
[1] ATO, Deceased Estates
[2] ATO, Inherited Property and CGT
CPD Quiz
The following CPD quiz is accredited by the FAAA at 0.5 hour.
Legislated CPD Area: Tax (Financial) Advice (0.5 hrs)
ASIC Knowledge Requirements: Estate Planning (0.5 hrs)
please log in to start this quiz
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