Exchanging investment or business real estate for other real estate better suited for your business can be accomplished tax free.

When is a Final Income Tax Return Required? When is a Final Income Tax Return Due?

A final income tax return is required if the gross income of a decedent exceeds the standard deduction amount in the year of death. The death of a taxpayer does not affect the standard deduction amount. A taxpayer is entitled to a full standard deduction regardless of the date of death. The 2022 standard deduction amount for single individuals is $12,950 ($14,700 for individuals age 65 or older).

The death of a taxpayer terminates a taxpayer’s tax year. Income received after a decedent’s death is included on the income tax return of the decedent’s estate ⁱ. Regardless of a taxpayer’s date of death, the due date for filing a decedent’s final income tax return is April 15 of the following year. The due date can be extended to October 15 of the following tax year. An extension of time does not extend the time to pay taxes due on the decedent’s final Form 1040. Interest and penalties will be incurred if taxes due on the decedent’s final Form 1040 are not paid by April 15 of the following tax year.

Election to File Joint Income Tax Return

A decedent can file a joint tax return with the surviving spouse so long as the spouse did not remarry before the end of the tax year. The executor of an estate makes the decision to file jointly with the surviving spouse.

A joint tax return should be considered when one spouse’s income does not absorb the lower tax brackets or if capital losses can be utilized. Separate tax returns should be considered if the income of one spouse is disproportionate to the amount of his or her medical expenses. Medical expenses in excess of 7.5 percent of a taxpayer’s adjusted gross income are deductible.

Calculation of Taxable Income on Decedent’s Final Income Tax Return

A taxpayer’s tax year ends upon death. Income accrued but not received before a decedent’s death is not included on a decedent’s final income tax return. Common examples of accrued income include unpaid salaries, commissions, and sick and vacation pay. Accrued income not paid prior to a decedent’s date of death is included on the income tax return of a decedent’s estate.

Generally, interest earned on series E or EE savings bonds is included in a taxpayer’s income in the year the bonds are redeemed. The executor of an estate can elect to include interest earned prior to a decedent’s date of death on the final tax return of the decedent. If this election is not made, all interest earned on redeemed savings bonds are included on the income tax return of the decedent’s estate. The election should be considered when a decedent died early in the tax year and otherwise wasted deductions such as the standard deduction could be used to offset income.

Medical expenses unpaid at a decedent’s death but paid within one year of death are deductible on the decedent’s final income tax return. No deduction is allowed on the estate income tax return of a deceased individual.

Capital losses and net operating losses not deducted on a decedent’s final income tax return are lost. Capital losses and net operating losses not used on a decedent’s final income tax return are not deducted on a decedent’s estate income tax return.

A deceased taxpayer’s share of partnership income or loss is included on the final income tax return of the taxpayer ¹. A partner’s tax year closes on the partner’s date of death. Partnership income or loss occurring after a partner’s death is included on the income tax return of the decedent’s estate.

The type of business transaction is an important consideration when planning to minimize income taxes. The form of entity should be considered from a perspective of taxes associated with yearly income and the taxes associated with the future sale of a business.

FORM OF PURCHASE AND SALE

The purchase of a business can take the form of an asset purchase or an equity purchase. If you are the purchaser of a business an asset purchase is generally more tax friendly. An asset purchase results in a tax deduction for depreciation and amortization. The cost of equipment and other tangible assets can generally be fully deducted in the year of purchase by utilizing the asset expensing election and bonus depreciation rules under the Internal Revenue Code. The real estate portion of an asset purchase is recovered over a minimum period of 27.5 years excluding the purchase price allocated to land that is not depreciable. The cost of intangible assets such as customer lists and goodwill are recovered over a period of 15 years.

If you are the seller of a business, an equity sale is generally more tax advantageous. The sale of an equity interest held for more than one year is taxed at the long-term capital gains rate with certain exceptions related to tax rules that are meant to prevent the conversion of ordinary income into capital gains income. Long-term capital gains rates vary based on overall income, but they are always lower than a taxpayer’s ordinary income tax rate.

CHOICE OF ENTITY

Businesses can be taxed as C corporations, S corporations, partnerships, or sole proprietorships.  C corporations are taxed as a separate entity. The owner(s) of S corporations and partnerships personally pay the tax on the entity’s income. A Limited Liability Company (LLC) is a common form of business ownership that does not have a separate tax scheme under the Internal Revenue Code.  LLCs can elect to be taxed as a C corporation, S corporation, or partnership.

Because C corporations are a separate taxable entity, they provide the opportunity for small businesses to split income between the entity and the business owner(s). This can result in a lower average tax rate applied to overall income. State taxes must also be considered in a C corporation tax scheme.

The income from entities other than C corporations is taxed at an individual owner’s income tax rate. Individual tax rates are often higher than the 21 percent federal corporate tax rate. The selection of a pass-through tax scheme is often made by considering the tax consequences of a future business sale. An asset sale of a pass-through entity avoids the potential double taxation of an asset sale by a C corporation.

ASSET ALLOCATION PURCHASE AND SALE OF BUSINESS ASSETS

An asset purchase of a business requires both the buyer and seller to allocate the same purchase and sales price based on the fair market value of each individual asset included in the transaction. The cost allocation must be provided to the IRS and is included in the tax return of both the buyer and the seller. The purpose of this rule is to prevent an asset allocation by the seller constructed to utilize potential long-term capital gains rates or by the purchaser to allocate the purchase price to assets qualifying for accelerated depreciation deductions.

The receipt of a gift or inheritence is free of income taxes. If you sell the gift or inheritence you may incur income taxes.

This chart compares Conventional IRAs with Roth IRAs.

The lift-time exemptions for gift and estate taxes are doubled through 2025. Now may be the time to consider making gifts to minimize estate taxes.

Social Security benefits are taxable for most recipients. The amount of benefits subject to an income tax is dependent on overall income.

Traditional and Roth IRA’s offer tax deferred or tax-free savings for retirement. Distribution rules vary depending on the type of IRA. Penalty exemptions may apply to early distributions.