When an individual dies, a person selected as the decedent’s representative prepares and files a federal income tax return for the year the individual dies. Income through the date of death should be included on the final tax return. The gross income of the decedent should be calculated including the gains, profits, and income that the individual actually and constructively received a taxable year. A taxpayer’s taxable year ends at the event of his/her death[i]. The part where the taxpayer was alive can only be calculated as a taxable year[ii].
Returns should be filed using the same method of accounting the taxpayer used before death[iii]. In the case of cash basis taxpayers, the final return includes only those items of income which were actually or constructively received by the taxpayer up to the end of his/her death day. All deductions made for expenses from the income can only be calculated in the final returns only to the extent that were paid by the taxpayer before his/her death[iv]. Salary, wages, and bonuses in the form of checks not cashed that are received before death of the individual should be included in the final returns.
If the taxpayer used to file returns based on an accrued income basis, the incomes and deductions accrued up to the date of death of the decedent should be added in the final returns filed[v]. Any amount accrued to the estate of the decedent only because of the reason of the person’s death, the amount cannot be added in the final returns[vi]. This income will form part of the decedent’s income as a contingent income claim[vii]. Accrued or unpaid compensation that includes vacation, sick pay, and commissions are taxable to the estate of heirs when actually received.
Dividends and interest checks received by a taxpayer before death also are included in the final returns. If the taxpayer died after a dividend was declared but before the payment date, it is only reported by the ultimate recipient.
In the year that the taxpayer passed away, tax can be computed for amounts used by the taxpayer under the method of accounting used by the taxpayer. However, if a decedent taxpayer had no regular accounting method, the person can be treated as a cash basis decedent. Therefore, only amounts actually or constructively received by the person during such year shall be included in the final returns[viii].
For a cash basis decedent, losses from sales or exchanges, worthless stocks, casualty, theft losses, and bad debts can be deducted in the final returns filed even without actual payment. Such deductions depend on whether these items became worthless before the decedent’s death.
Items that can be normally included in the gross income of an individual that a decedent had not received until death cannot be included in the decedent’s final return. However, those items can be included in the gross income of the estate or of the beneficiary of the decedent who receives the income.
[i] 26 CFR 1.451-1
[ii] 26 USCS § 443
[iii] 26 CFR 1.451-1
[iv] 26 USCS § 461
[v] 26 CFR 1.461-1
[vi] 26 USCS § 461
[vii] 26 CFR 1.691(a)-1
[viii] 26 CFR 1.451-1