January 25, 2022
The death of a spouse is an unspeakably tragic time. While reeling in the aftermath, most people (understandably) forget about the looming tax repercussions that come with being newly widowed.
Unfortunately, there’s no evading the new tax requirements that must be met—and the deadlines by which you must act.
Be prepared for a change in tax bracket
A change in tax bracket is one of the tax repercussions that’s most overlooked after the death of a spouse. Because filing taxes jointly offers many tax advantages, reverting back to a single-filer status can bring a lot of abrupt changes to your tax situation and, potentially, your lifestyle.
For example, while it’s possible your tax rate may stay the same after a spouse’s death, it’s more likely to increase, even as your income decreases (an unfortunate happening that’s often referred to as the “widow’s penalty”). This is because, as a single filer, you will reach a higher tax bracket more quickly.
It’s important to remember that the year of a spouse’s death is the last year you will file taxes jointly, so it’s the time to take advantage of the more friendly taxpayer rules that exist for joint filers. After this year, you either have to file as a single person or as a surviving widow(er) if you have dependent children. Unlike single persons, surviving widow(er)s can retain the benefits of joint filing for up to two years after the spouse’s death.
To sell or not to sell your home
In the trying time following a spouse’s death, you’re forced to make a lot of serious decisions—and quickly. Often, one such decision is to sell or keep your home.
While some may be forced to sell their home because they need the cash to adjust to their unexpected lifestyle change, others may decide to sell as a means of starting a new chapter in their lives. No matter what you choose, pay attention to the time.
As a joint filer, you can get an exemption of $500,000 on the sale proceeds of your home—but for single filers, that exemption is only $250,000. Surviving widows can get the same $500,000 exemption if they sell the home within two years of the spouse’s death and if they haven’t remarried.
What to do with retirement accounts
When it comes to retirement accounts, there is again pressure to act quickly, as different timetables can yield different tax implications for the surviving spouse.
In the event of spousal death, many are advised to roll over any qualified retirement accounts (e.g., 401(k)s or IRAs) into their own name right away. But depending on your specific situation, this may or may not be the most fitting choice, and it behooves you to consider other options.
If you exercise a spousal rollover and put the retirement account in your name, then required minimum distributions (RMDs) would begin when you turn 72. This is something to consider if you're considerably younger than your spouse was, as it means you can keep the money in a tax-deferred account for a longer time. If you’re younger than 59 ½, however, this may not be the most suitable option. By putting the account in your name, you’re subjecting yourself to a 10% penalty should you need to withdraw any money from it before you turn 59 ½.
Alternatively, you can keep the retirement account in the name of the deceased; RMDs would then begin when your spouse would have turned 72. This also means that there would be no penalty if you needed to make withdrawals from the account before you turn 59 ½.
There’s also the option to divide retirement accounts, e.g., roll over some but not all assets into your name. Doing so allows you to leave some assets in the inherited account from which you could make penalty-free withdrawals even when you’re younger than 59 ½. You could also convert some assets to a Roth IRA, where qualified withdrawals are tax-free. Note that making this conversion may be best when you’re still eligible for joint-filing rates and brackets.
There’s no deadline for making a spousal rollover, so, unlike other time-sensitive decisions that must be made after death, there’s more time to plan for making changes to retirement accounts.
What about assets outside of retirement accounts?
You may also need to make considerations for assets that exist outside of retirement accounts, e.g., a home, stocks, or a business.
We’ve already touched on tax implications for your home. For stocks, taxes aren’t typically due until you, the heir, sells them, at which point you would owe tax only on the growth that took place after the death of the original owner, your spouse. This is a resetting of the cost basis (commonly referred to as the “step-up”) and is worth consideration if selling assets after death, as a lower gain usually means a lower tax bill.
Also bear in mind that rules vary depending on whether you live in a community property state or a common law state.
Many individuals don’t have to file a federal Estate tax return because their taxable estate is less than the estate tax exemption, presently $12,060,000 for an individual. In many cases the deceased exemption is wasted because they don’t have sufficient assets in their own name. If they file an estate return, a special election can be made to transfer the deceased spouse’s exemption to the surviving spouse, known as the “Portability Election”. The election is only good for saving the federal exemption. To save the New York estate tax exemption, presently $6,110,000 for individuals, planning is needed, pre- and post-death. You can contact your Perlson LLP representative for more information on this issue.
And there’s more
Attention must also be paid to withholding or estimated taxes. If your spouse was largely in charge of these payments, you’ll now need to stay on top of what you owe or risk facing underpayment penalties come tax time. In the face of the many tax repercussions that follow the death of a spouse, this is another area that is frequently overlooked—and one that can end up costing you dearly.
The death of a spouse plunges one into uncharted waters, where, among grief and emotional upheaval, one must also contend with new tax requirements, deadlines, and changing rules.
Perlson LLP professionals can help you better understand these and other tax repercussions and offer guidance on what decisions you may need to make. Contact us at your convenience at 516-541-0022.
It’s hard to believe, but once again it’s time to think about year-end and all the things you need to do to be ready for the 2023 tax season