RTS #021 Death and Taxes

Financial planning is full of difficult topics that people would often rather ignore than plan far. We see this constantly with taxes as we work with taxpayers to start seeing this as a more than once-a-year conversation. Death is an even more challenging topic and one that most of us are hopefully not reminded of by the IRS at least annually as we file a tax return. The overlap of death and taxes is almost guaranteed to be ignored by most people unless there is someone in their life willing to navigate this difficult, even if potentially valuable, topic.

When it comes to death and taxes, particularly for married couples, there are some things that will change no matter what. A big one is filing status. We regularly see the first year a surviving spouse has to file “Single” as a painful tax year, not only because their taxes inevitably go up, but for clients who are new to working with us, they are often shocked by that increase because it’s been decades since they filed as anything other than married filing jointly. While eventually, the surviving spouse will have to file Single, it is important to understand the options that might be available.

Let’s look at some examples for Bob and Sue:

If Bob passes away in 2023, regardless of when Sue will be able to select Married Filing Jointly as her filing status (almost always the most advantageous filing status) for 2023. After the year of Bob’s death, understanding Sue’s options becomes slightly more complicated.

If in 2024 (the year following Bob’s date of death), Sue has a child, stepchild or adopted child that qualifies as a dependent, she may be eligible to file using the Qualifying Widower status. This allows a single taxpayer to continue using the same standard deduction and tax rates as they had when they filed jointly, so it potentially saves a significant amount of taxes. Sue can qualify for this status for up to two years following Bob’s date of death (so in our example 2024 and 2025) assuming she meets the other criteria including having a child, stepchild or adopted child that qualify as a dependent in each of those years.

After 2025, even if Sue still meets the other criteria she will no longer be eligible for the Qualifying Widower status. If Sue still has dependents she may be able to switch to Head of Household (which sits between Married Filing Jointly and Single as far as tax benefits go) for 2026, but the definition of who qualifies as a dependent is more broadly defined for this filing status. Under Head of Household status qualifying dependents are no longer limited to children, stepchildren and adopted children (which means if Sue didn’t meet the criteria for Qualifying Widower in 2024 and 2025 she may have been eligible for Head of Household status). Once she is outside those first two years evaluating filing status is the same as for any other tax payer.

Each change in filing status can have a big impact on a taxpayer’s annual bill so it’s important to understand and be ready for. The likely increases in taxes as these statuses change is another reason that having the flexibility of large Roth accounts can be incredibly advantageous.

What can you do about it?

Include tax education as a regular part of broader communications and on your meeting agendas. The topic doesn’t need to dominate the discussion but should be something that is established early in the relationship and revisited often. You should have (and revisit and update) a checklist for things to do when a client passes. The first thing of course is allow for time to properly grieve but the reality is there are other things that need to be done from there. Helping a client understand how their taxes will change in the coming years and making sure the proper filing status is selected each of those years is just one example.

Happy Tax Planning!