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Editor’s Note: Many Widows and Widowers find tax time confusing, especially the first year or two after your spouse has died. I’ve asked Kelly Phillips Erb, tax attorney and tax blogger, for some tax advice which she has generously shared here. Kelly first wrote this article in 2009, so there may be some dated information, but I wanted to share it anyway. This post was originally posted on Type-A Parent.
Benjamin Franklin once famously wrote in a letter that "in this world nothing can be said to be certain, except death and taxes." I imagine that Benjamin Franklin never had to deal with both at the same time. Taxes, especially income taxes, can be confusing at the best of times - and even moreso at a time when things may feel like they're in a constant state of flux. Here are a few tips to help you sort it all out:
1. You don't have to make decisions about filing status immediately. While there may be some tax planning opportunities available following the death of your spouse, there is usually no reason to make a drastic change in the first year. The easiest - and usually the most advantageous - choice is to file a joint return with your deceased spouse for the year of death. This is true whether your spouse died in January or December. Your joint tax return will be due on April 15 of the following year, just like always. Note: If you remarry in the year of your spouse's death, you can't file a joint return with the deceased spouse. You can file a joint return with your new spouse or you and your new spouse may each file a separate return.
2. Pay attention to the fine print. Even though you're likely filing a joint tax return, the IRS has a few quirky rules that you'll want to follow. As the surviving spouse, you'll sign the return as usual. However, there must be two signatures on a joint return. If there is no personal representative for your spouse's estate, you should sign the return and write in the signature area "filing as surviving spouse." If there is a personal representative appointed for the estate, that person must also sign the return (attach a copy of the court certificate to the return). Before you pop the return in the mail, write the word "Deceased" after your spouse's name in the name and address section of the return along with the date of death.
3. Understand your choices for filing status. For the calendar year after your spouse's death, you have a few options for filing status. If you qualify for more than one, run the numbers and see what makes the most sense.
Single. You can file as single if you remain unmarried at the end of the tax year. From a tax savings perspective, this is generally the least desirable of your options.
Qualifying widow with dependent child. If you meet certain criteria, you can file as a qualifying widow with dependent child for the two tax years immediately following the year of the death of your spouse but not for the year of death. To qualify, you must have been eligible to file a joint return in the year of death (even if you didn't) and have not remarried. You must also claim a qualifying child (which includes a foster child, adopted child or stepchild) as your dependent and have provided more than half the cost of keeping up a main home for that child for the entire year. This status usually makes the most economic sense because the standard deduction is the same as that for a married couple filing jointly.
Head of Household (HOH). You can file as HOH if you are unmarried on the last day of the year; you paid more than half the cost of keeping up a home for the year; and a "qualifying person" lived with you in the home for more than half the year (except for temporary absences, such as school). The list of "qualified persons" is kind of tricky but includes a child or grandchild who lived with you more than half the year, and may include a parent. If you file as HOH, you will likely have a lower tax rate and a higher standard deduction (both good things) than filing single.
Married Filing Jointly or Married Filing Separately. If you remarry, you must file as married filing jointly or married filing separately. It doesn't matter what month you remarry - your filing status is determined as of the last day of the year.
4. Understand what's taxable. The tax rules don't change after the death of your spouse but your sources of income may. Generally, if Social Security benefits represent your only income during the year, those benefits are not taxable. However, if you received income from other sources, your Social Security benefits may be taxed if your modified adjusted gross income is more than the base amount for your filing status. To figure out if this applies to you, add 1/2 of your Social Security benefits to your other income. For 2009, if that amount is more than $25,000 and you file as single, HOH or qualifying widow with a dependent child, a portion of those benefits will be taxable.
5. Understand what's not taxable. The proceeds of life insurance are generally not taxable for federal income tax purposes. There are two notable exceptions. If the amount payable to you is more than the actual death benefit, the overage (usually in the form of interest or dividends) is taxable. For example, if the death benefit was $100,000 and you received $100,123, the $123 is taxable. Additionally, to the extent that the life insurance payout represents something other than a death benefit, there may be a taxable component - your life insurance company should advise if this is the case.
6. You may have to file and pay taxes separately for your children. As a rule of thumb, you would not include Social Security benefits for your children on your personal income tax return. However, it is your responsibility to make sure that your minor children are compliant with the tax laws. To determine whether you need to pay taxes (or even file tax returns) for your children, use the same formula to figure their benefits as yours (see #4).
7. Don't touch retirement plans. At least not in the beginning. In most instances, you'll have a few choices to make. For example, you may wish to roll the account over into your own retirement account. Or you may elect to continue to treat the account as your spouse's account and defer taking the RMDs (required minimum distributions) until your deceased spouse would have been required to take them. Or you may want to engage in a little post-mortem estate planning involving disclaimers or trusts. But if you take the cash out as a lump sum early on, you may be barred from making these choices later.
8. Put together a good financial team. The sooner, the better. You may not even need their services right now but you don't want to be scrambling for help at the last minute. Put together a team for the "some day" when you'll need it - get comfortable with your team early on and introduce them to each other.
Who do you want on your team? Consider a core group, usually a financial/investment advisor, a family attorney and a tax preparer (you can find some tips for finding a good tax preparer here). You may wish to add others to your team but these three are a good starting point.
9. Don't be afraid to ask questions. Don't be fooled into thinking that your questions aren't "big" enough or that you don't have enough money to worry about. Some of the best questions can be about the smallest details. A good team will understand and respect this.
Nobody expects this to be easy. People want to help - even the IRS (1.800.829.1040). Just ask.