Tax Essentials for New Widows
Losing your partner can be emotionally debilitating, and on top of dealing with that aspect of the loss, you also have to handle numerous financial issues. Wondering how becoming a widow affects your income tax situation? Here’s a look at some of the essentials.
The good news is that most life insurance payments are tax-free. You don’t have to report the funds as income on your tax return. Moreover, you don’t have to pay any income tax. In most cases, the money is yours, free and clear.
As of 2019, however, if your spouse’s half of the estate is worth more than $11.4 million, the IRS may assess the estate tax on the assets over that threshold, and in these rare situations, the life insurance may face some tax. That said, in most cases, the estate passes tax-free to the spouse. The IRS does not assess the estate tax until the spouse dies — at that point, the threshold doubles to $22.8 million.
Filing Status for Widows/Widowers
The year your spouse dies, you get to claim married filing jointly as your filing status. If you usually use married filing separately, talk with your financial advisor to decide if that’s still the right decision. Most couples get more advantages by filing jointly or together. Whether your spouse died on the first day or the last day of the tax year, you get to claim their entire standard deduction. As of the tax year 2018, the deduction for married couples is $24,000.
For the following two tax years, you can claim qualifying widow/widower as your filing status but only if you don’t remarry and you claim a dependent on your return. As a qualifying widow/widower, your standard deduction is still $24,000. In contrast, if you don’t care for a dependent, you have to claim the single deduction which is only $12,000. If you get remarried in that time frame, you claim the married filing jointly status with your new spouse.
After those two years, if you get remarried, you claim the status that applies to your situation. If you don’t get remarried and you have no dependents, you claim the single deduction. Finally, if you have dependents, you get to claim the head-of-household filing status which is an $18,000 deduction.
Stepped Up Basis for Capital Assets
If your spouse leaves you any assets, you get to enjoy a stepped-up basis, which reduces potential capital gains tax. To explain, imagine that your spouse bought stocks for $10,000 — that figure is the basis for your spouse. At the time of their death, the shares were worth $40,000. If your spouse had sold those stocks, they would have reported and paid tax on that $30,000 capital gain.
In contrast, when you inherit the stocks, the basis is stepped up to $40,000. If you sell the shares right away for $40,000, you don’t have to report a gain. Moreover, you don’t have to report or pay tax on the sale. If you sell the stocks the following year when they’re worth $45,000, you only have to pay capital gains tax on the $5,000.
With jointly owned property, you usually receive a stepped-up basis on your spouse’s half of the property. However, in community property states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin) the entire value of the shared property receives a stepped-up basis.
Selling Your Home
The government offers couples a $500,000 capital gains exclusion on the sale of their primary home. Singles get a $250,000 exclusion. You only have to report a capital gain if you earn more than that on the sale. If your spouse dies and you sell the home within two years, you get to use the capital gains exclusion for couples. After that point, you only qualify for the singles exclusion, but again, the change in your stepped-up basis as explained above can help to reduce your total overall gains regardless of when you sell the home.
With Independent Retirement Accounts (IRA), 401(k)’s, and other retirement accounts, the rules vary based on your age, your spouse’s age, and what you do with the funds. If you like, you can take a lump sum distribution, regardless of your spouse’s age. That requires you to pay income tax on the entire amount, but you also avoid the 10% penalty for early withdrawals.
Once people hit age 70.5, they must take distributions from their IRA and 401(k) retirement accounts. If your partner was already taking distributions, you could roll the funds into an inherited IRA. Then, you continue taking distributions based on the longer of your schedule or your partner’s schedule. Even if you are younger than 59.5 years, you don’t face additional penalties on these withdrawals. Alternatively, you can roll the funds into your retirement account, but then, you face a 10% penalty if you take distributions before age 59.5.
If your spouse was under 70.5, you could also transfer the funds to your account. At that point, you make distributions and pay taxes as usual. You can also put the funds into an inherited IRA which mostly follows the same rules as your account. However, you don’t incur the 10% penalty on early withdrawals if you are under 59.5. There are also five-year inherited IRAs, which are similar to the traditional inherited IRA but you have to distribute all the funds within five years.
Social Security Checks
If your spouse has paid into the Social Security program, you may qualify for Social Security benefits for survivors. You receive a certain percentage of your spouse’s monthly benefit based on your age and disability status as follows:
- Widow/widower at full retirement age — 100%
- Widow/widower at age 60 to full retirement age — 71.5 to 99%
- Disabled widow/widower at age 50 to 59 — 71.5%
- Widow/widower of any age, caring for a child under age 16 — 75%
- Child under age 18, or age 19 and in elementary or secondary school — 75%
Families face a maximum amount which is between 150% and 180% of the deceased person’s full benefit amount. Because of that, a family receiving survivor’s benefits for three children may receive the same amount as a family receiving benefits for two children. Similarly, if a widow is already receiving maximum benefits for their children, they may not receive any additional amounts by applying in their name.
As of 2019, if you are under full retirement age and earn over $17,640, your social security benefit is reduced by $1 for every $2 earned above the threshold. As soon as you reach retirement age, the threshold increases to $46,920.
Even divorced spouses may be able to receive some of these benefits. Usually, you must have been married for at least ten years. Furthermore, you can’t be remarried, you must be over age 62, and the benefits from your deceased ex-spouse must exceed the benefits you earned on your own.
Social security benefits are taxable based on your situation. If your Social Security payments plus your other income is above the standard deduction relevant to your tax situation, you may face some income tax. However, if you receive Social Security benefits for your children, the payments come in their names. In other words, you don’t have to report those amounts as taxable income on your personal tax return.
Most children shouldn’t incur any income tax on their Social Security payments. As a general rule of thumb, you add together half of their Social Security payments with all their other taxable income. As long as the sum is less than $25,000, they shouldn’t face income tax.
Support From Other Countries
In cases where your spouse earned credits in another country’s social security system, you may receive benefits from that country. The tax rules on these payments vary based on the tax treaty between the United States and that country. Often, the benefits are only taxable in the United States if they are taxable in the country of origin — for instance, bereavement support payments from the United Kingdom are not taxable there so they should also not be taxable in the United States. Again, however, you may want to consult with a tax advisor to learn more about your specific situation.
If your spouse died of an extended illness, you might be able to claim a deduction for their medical expenses. As long as you or the estate pays medical bills within a year of your spouse’s death, you can claim those bills as if they were paid the date they were incurred. Then, if the total amount exceeds 10% of your adjusted gross income (AGI), you can claim a deduction for the amount that is greater than 10% of AGI. If your spouse was age 65 or older, you only need to exceed 7.5% of AGI to claim a deduction.
Unfortunately, you can’t deduct funeral expenses from your tax return. However, if you have to file a return on behalf of your spouse’s estate, you can deduct funeral expenses from the estate return.
If you’re juggling mourning a tax debt, you are not alone. Tax professionals can help you through this confusing and stressful situation. To learn more, contact us today to talk to one of the tax debt specialists in our network.