The death of a spouse is never an easy situation to deal with. On top of coping with your own grief, there are oftentimes mountains of paperwork and financial matters to handle, as well as decisions to be made in regards to his or her estate. To make matters even more complicated, your spouse’s death will affect your 2015 federal income tax return, and will have other tax implications too. Following are some of the most important things to know:
1. Required minimum distribution (RMD) rules for inherited retirement accounts are not negotiable.
Your RMD is the amount you must withdraw from your investment account(s) each year. You generally have to start taking withdrawals from IRAs or retirement plan account when you reach age 70½. Roth IRAs do not require withdrawals until after the death of the owner. If you inherited your deceased spouse’s IRA or other qualified retirement plan account, the same rules apply.
Make sure you pay close attention to your spouse’s age when he or she died and your own age, as you may be required to take an RMD this year — and pay the resulting extra income tax. Important note: You’ll usually get more favorable RMD tax results if you treat the inherited account as your own.
Warning: RMD rules are non-negotiable, and you’ll pay an expensive price for failing to meet the requirements. Ignoring the rules could result in owing a staggering 50% of that money to Uncle Sam. The penalty is charged on the difference between the required amount for the year and the amount actually withdrawn during the year. If you don’t want to give up half of your spouse’s hard-earned IRA funds, make sure you pay close attention to RMDs each year.
2. You’re temporarily entitled to a larger home sale gain exclusion
Even though you can’t file a joint return after your spouse dies (unless you remarry), you’re still entitled to the larger $500,000 joint-filer gain exclusion for a principal residence, sale if it occurs within two years after your spouse’s death.
While this rule certainly works in your favor, it’s important to pay attention to the deadline, as the $500,000 joint-filer gain exclusion will end exactly 24 months after your spouse’s death. You should also be aware the exclusion won’t make a difference unless the gain from selling your home is more than $250,000.
3. You get a basis step-up for inherited taxes
If your deceased spouse left you appreciated capital gains assets, such as securities or real estate, you can you can increase the federal income tax basis of those assets to reflect their fair market value (FMV) as of the date of death. According to the Internal Revenue Code website, you can also use the FMV as of six months after the date of death if the executor of your deceased spouse’s estate makes that decision.
This means that when you sell an inherited asset that has received a “basis step-up,” you’ll only owe federal capital gains tax on appreciation that occurs after your spouse’s death.
4. You can still file a joint tax return for 2016
If your spouse died in 2015, you were considered single throughout that entire year for federal income tax filing purposes. The only exception would be if you remarried by Dec. 31, 2015.
Even though you were considered single, you’re still allowed to file a final joint Form 1040 with your deceased spouse for 2015, and as a result experience the benefits of tax rules working in your favor. That final joint return can include your deceased spouse’s income, deductions and credits up until the time of his or her death, as well as your own for all of 2015.
The bottom line: While you weather the difficult process of dealing with life without your spouse, it’s important to be aware of certain tax rules that can still work in your favor. Talk to a tax and/or financial expert if you have any questions regarding the rules of how becoming a widow or widower could impact your financial future.