May 21, 2024

The unfortunate reality of taxes after death

Many people don't associate taxes with life after death, and rightfully so. It's the last thing anyone wants to think about, but here's what you should know.

As Benjamin Franklin once said:

“Nothing is certain except death and taxes”

What he failed to point out is that even after you pass away, you still have taxes to pay.

Yes, that’s right. While your loved ones are mourning your passing, the ATO is eagerly waiting to receive their final pay day from you.

What happens to your finances when you pass away?

When you pass away, all the assets you own and liabilities you owe form part of your deceased estate.

These assets can include your bank accounts, real estate, your car, investments, and personal belongings such as jewellery. The assets in your estate, are distributed to the beneficiaries, which would typically be your family members or loved ones.

The estate also includes debts that you owe, such as your outstanding tax obligations to the ATO.

Do I need a will?

If you pass away without a valid will, this is called ‘dying intestate’. In this situation, your assets will be distributed according to the inheritance laws of each state and territory.

Looking at NSW as an example, if your spouse survives you, they will inherit everything even if you have children.

It’s always wise to prepare a will which dictates your wishes, particularly if you have accumulated significant wealth in your lifetime. This should be completed as part of a broader estate planning exercise prior to your passing.

One can only pray that your loved ones will respect your wishes and not contest the will.

Wills are often contested when some relatives are excluded from the will or don’t receive what they believe is “their fair share”.

Contesting the will can be a lengthy legal battle and can create delays in winding up your estate.

Do I need a will to protect my estate from taxes after I die

Who will manage my finances when I pass away?

One of the most important instructions you need to include in your will is who will be the executor of your estate. The executor will be responsible for managing your financial affairs after you pass away.

The executor must be over 18 years of age and should be someone you trust to carry out your wishes.

Spouses, adult children, or siblings are commonly appointed as executors. You can also choose to have more than one executor.

What does the executor need to do?

There will be various submissions and tax lodgements that will need to be made to the courts and to the ATO. Needless to say, there is a lot of paperwork involved. It would be wise for the executor to seek professional assistance from a lawyer and accountant who will help administer the deceased estate.

First, the executor will need to receive a Grant of Probate from the Supreme Courts. The purpose of the Grant of Probate is to confirm the validity of the will, identify the executor/s and provide an inventory of assets and liabilities of the deceased.

Once this document is stamped by the Supreme Court, it gives the executor the authority to manage the estate. There is a fee attached to the application for probate which varies from state to state. In NSW, this fee can be as high as $6,652 if you have an estate valued at over $5 million. Nonetheless, these fees should be paid from the estate’s funds.

Finalising the deceased person’s taxes

Once you have received probate, the ATO will need to be informed about the person passing away by completing a ‘Notification of deceased person’ form. It can take up to 28 days for the ATO to process this form.

Subsequently, the executor will need to submit a ‘TFN application for the deceased estate’. This is because the deceased estate is a separate entity to the deceased individual and is in the form of a trust.

The accountant will then need to prepare what’s called a ‘Date of Death’ tax return which is the final tax return for the financial year which the person passed away, but only up to their date of death.

Finalising the deceased estate's taxes

Once the tax obligations for the deceased individual have been taken care of, the deceased estate tax return needs to be prepared.

The first income year of a deceased estate starts the day after the person passed away, and ends on the next 30 June.

It is in your best interest to wrap up the deceased estate as quickly as possible, especially if the estate is holding income producing assets, such as a rental property.

The estate will be required to pay tax on any income that is earned and will be required to lodge a trust tax return each year it is still active.

For the first 3 years of the estate, you can apply to use the concessional tax rates which are the same as the individual income tax rates. This provides the benefit of the full $18,200 tax-free threshold.

If the estate is still not wound up after 3 years, it will be assessed at higher tax rates in years 4 and onwards, and the tax-free threshold reduces to only $416.

Is there inheritance tax in Australia?

Unlike other countries, Australia does not currently impose an ‘inheritance tax’ or ‘death tax’. Although, there has recently been some chatter by the labour government about introducing such taxes in the future. I’m sure that will win the public over in the polls…

Whilst there aren’t immediate taxes to pay on inheritance, the person inheriting the asset may need to pay tax when they subsequently sell the asset in the future. This is particularly important if you’ve inherited major assets such as a family home which was the deceased person's main residence.

To avoid paying Capital Gains Tax (CGT), you would need to sell the property within a two-year period, regardless of whether you used the property as your own main residence or to earn income.

Similarly, the cost base of any assets you inherit will depend on when the deceased person acquired the assets themselves (pre-CGT or post-CGT). This is one of the many reasons why you should always maintain good record keeping habits. From my experience, wrapping up the estate can become messy and more time consuming when this historic information is not readily available.

Closing remarks

Whilst this article focuses on the financial side of death, I want to take a moment to acknowledge the spiritual side which doesn’t have to be so dark and gloomy.

Without going into a deep discussion about faith (I can’t help myself sometimes), our physical bodies will inevitably die one day, but it’s comforting to know that our spirit will live on for eternity.

The Bible tells us in John 3:16,“For God so loved the world that He gave His only begotten Son, that whoever believes in Him should not perish but have everlasting life.”

I don’t know about you, but I’m looking forward to eternity in heaven. There are no taxes there either because Jesus has paid all our debts!!