Tax Changes to Consider After the Death of a Spouse, Ep #166

Most of us believe we’ll always have more time with our spouse, but when that time is cut short, we’re often left with too many questions and not enough answers. On today’s show, we tackle the emotionally challenging subject of losing a spouse.

Between planning a funeral, notifying people, and taking calls, it’s hard to find time to grieve, much less think about the financial consequences and tax changes you have to deal with in the coming weeks. Part of our responsibility during this difficult time is to walk you through the steps of navigating the administrative part of handling a loved one’s resources.

Listen to this episode to learn about the tax changes to consider when dealing with the death of a spouse.

What tax filing status should I use for the year in which my spouse passes?

If you’re not remarried by the end of the year, you are permitted to file as Married Filing Jointly. However, it may be worth exploring other filing options (particularly Married Filing Separately) to see if another status makes more sense for your situation.

At the time of filing, if a personal representative has not been appointed, the surviving spouse can write “filing as surviving spouse” in the area where the decedent would have signed the return.

What tax filing status should I use in the following year?

The year after your spouse dies, you have two options when filing. If you remain unmarried, claim dependent children on your return, and have paid over half of the costs associated with maintaining the home, the IRS permits you to file as a Qualified Widow/Widower for the two tax years post-death.

If you have no dependents, you will file as a single, unmarried taxpayer in all years following the death of your spouse, barring remarriage. This does come with a lower standard deduction, but, depending on your financial situation, it may increase the possibility of itemizing your deductions, so there is some planning opportunity here that you can explore with our ongoing tax planning services.

When my spouse passes, does the basis of our property and investments increase?

The answer depends on the state in which you live, as the rules are different for community property states and those which use joint tenancy. In North Carolina, a non-community property state, property that is owned jointly receives a one-half step-up in basis.

It’s crucial to follow up with the custodian (or advisor) on the account to ensure that the step-up in basis is appropriately incorporated, as this can result in material tax savings as the funds are sold.

What about Capital Loss Carryovers?

One strategy we often discuss with our clients is tax-loss harvesting during market downturns. These capital losses harvested can be used to offset capital gains and up to $3k in ordinary income each year on your tax returns. They carry forward until they’re fully used, however, there are certain specifications to know in the event your spouse passes away.

The IRS states that capital loss carryovers are only deductible by the taxpayer who sustained the loss. This is where understanding how accounts are registered becomes incredibly important.

If the capital loss carryover is attributable to an account owned solely by the spouse who passed, any carryover loss that is not absorbed on the tax return for their year of death is lost. If the capital loss carryover is attributable to an account owned by both spouses jointly, one-half of the carryover is allocated to the surviving spouse and can be used in future years while the half attributed to the decedent spouse is lost if not used in the year of death.

From a planning perspective, understanding which carryover may or may not be lost can present the opportunity to potentially harvest gains to soak up loss carryover that will be lost.

How does the death of my spouse impact taxes if I want to sell our home?

The IRS allows qualified taxpayers to benefit from the “primary sale exclusion.” To qualify, you must have lived in the home as your primary residence for more than two years and not used the home sale exclusion in the past two years. Qualified individuals can exclude $250k in capital gain and joint filers can exclude $500k in capital gain from taxation.

Regardless of the reason you may want to sell your house, the IRS provides a grace period of sorts for you to do so. If you sell your home within two years of the date of death and you owned the home jointly with your spouse prior to passing, you will remain eligible to exclude up to $500k in capital gain on the sale.

Are there any other things surviving spouses should consider for future tax years?

With so many life changes that come with losing a spouse, it’s easy to forget about adjusting withholding. With a lower standard deduction and your income possibly being taxed at a higher rate, if withholding isn’t adjusted, shortfalls often result.

The surviving spouse will also need to decide how to handle any retirement accounts they inherit from their spouse. This topic requires special care as a number of options are available to the surviving spouse and they need to consider their age and the age of the decedent spouse prior to making a decision on how to best proceed.

Outline of This Episode

  • [2:10] Which tax filing status to use in the year of death
  • [4:40] Which tax filing status to use in the following year
  • [8:43] Step up in basis
  • [12:26] Capital loss carryovers
  • [14:53] Tax impact of selling your home
  • [18:33] Other things to consider

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