Contents
- Inheriting money and assets
- Receiving income of a deceased estate
- Receiving a super death benefit
- Handling tax returns and estate income for deceased individuals
- Estate planning considerations
Losing a loved one is a challenging time, and managing the financial affairs of a deceased estate can add to the complexity. In Australia, there are certain tax considerations that beneficiaries should be aware of when inheriting money or assets. This article provides valuable insights and guidance on deceased estate tax, ensuring that Australian taxpayers have the necessary information to navigate the tax implications associated with managing a deceased estate.
Inheriting money and assets
In Australia, when it comes to inheriting money and assets, there are certain considerations and tax implications that beneficiaries should be aware of. While there is no inheritance tax, estate tax or death tax in Australia, beneficiaries may still have tax obligations related to the assets they inherit. Let’s explore two key considerations in more detail:
Capital gains tax (CGT)
Capital Gains Tax (CGT) is a tax imposed on the capital gain made from the sale of an asset. When a beneficiary inherits an asset from a deceased estate and later decides to sell it, CGT may apply. It is crucial for beneficiaries to assess the tax implications before disposing of any inherited assets.
Under the Australian tax system, CGT is calculated based on the difference between the asset’s cost base (generally the market value at the time of the deceased’s death) and the sale proceeds. The capital gain is then added to the beneficiary’s taxable income for the relevant financial year and taxed at their marginal tax rate.
However, it’s important to note that certain exemptions and concessions may apply, depending on the type of asset and the beneficiary’s circumstances. For instance, the main residence exemption may be available if the inherited property was the deceased’s main residence and certain conditions are met.
Income tax
Beneficiaries may also be subject to income tax on any income generated from the assets they inherit, such as dividends from shares or rental income from inherited properties. This income should be included in the beneficiary’s tax return and will be taxed at their applicable marginal tax rate.
When it comes to shares, beneficiaries should consider whether they want to retain the shares and continue receiving dividends or sell them. If dividends are received, they need to be reported as assessable income in the tax return. On the other hand, if the shares are sold, the CGT rules mentioned earlier will apply.
Similarly, if a property is inherited and rented out, the rental income needs to be declared in the tax return. However, beneficiaries may also claim deductions for expenses related to managing the property, such as property management fees, repairs, and maintenance costs.
It’s important for beneficiaries to keep accurate records of any income received and expenses incurred to ensure compliance with income tax obligations and maximize any available deductions.
Receiving income of a deceased estate
The estate of a deceased person may continue to generate income until it is finalized. Common sources of income include rental income from properties owned by the deceased and dividends from investments. If a beneficiary becomes presently entitled to the income of the deceased estate, the following steps should be taken:
Include income in tax return
The beneficiary should include the income received from the deceased estate in their personal tax return. This income can be categorized based on its nature, such as rental income, dividends, interest, or any other applicable income streams.
Information from the legal personal representative (LPR)
The legal personal representative (LPR) of the deceased estate, typically the executor named in the will, or an administrator appointed by the court, is responsible for providing the beneficiary with the necessary information to complete their tax return accurately. The LPR should provide details of the income received, including any relevant documentation, such as rental statements or dividend statements.
It’s essential for beneficiaries to communicate effectively with the LPR to ensure they have all the required information and documentation for their tax obligations.
Receiving a super death benefit
In Australia, superannuation (super) refers to the pension or retirement savings system. When a person passes away, their super balance may be paid as a death benefit to one or more beneficiaries. However, tax treatment varies depending on the circumstances:
Tax-free super death benefits
Super death benefits paid to dependents, such as spouses, children under 18 years old, or financially dependent adult children, are generally tax-free. The tax-free component of the super balance, which includes non-concessional (after-tax) contributions and any tax-free pension component, can be paid to the beneficiary without incurring any tax.
Taxable super death benefits
Super death benefits paid to non-dependents, such as adult children who are not financially dependent or non-related individuals, are generally subject to tax. The taxable component of the super balance, which includes concessional (pre-tax) contributions and any taxable pension component, may be subject to tax depending on the beneficiary’s circumstances.
The taxable portion of the super death benefit may be subject to tax at either the beneficiary’s marginal tax rate or a special tax rate, known as the “death benefits tax rate.” The tax rates can vary depending on the beneficiary’s relationship to the deceased and the nature of the payment.
Handling tax returns and estate income for deceased individuals
Handling tax returns and estate income for deceased individuals involves specific considerations and obligations. Executors, legal personal representatives (LPRs), and beneficiaries must navigate the process diligently to ensure compliance with tax laws. Let’s delve into the key aspects involved:
Lodging the deceased individual’s final tax return
When a person passes away, their tax affairs need to be finalized by lodging a final tax return on their behalf. The executor or LPR is responsible for preparing and lodging this return. The final tax return covers the period from the beginning of the financial year up to the date of the deceased’s death.
The final tax return should include all income earned by the deceased up to their date of death, including salary, business income, investment income, and any other applicable income sources. Deductions and offsets that the deceased individual would have been entitled to can also be claimed. It’s essential to gather accurate and comprehensive records of the deceased’s income and expenses to ensure the final tax return reflects their financial situation accurately.
Applying for a tax file number (TFN) for the deceased estate
A deceased estate is a separate legal entity for tax purposes. Executors or LPRs may need to apply for a Tax File Number (TFN) for the deceased estate to fulfill their tax obligations. The TFN will be used to lodge tax returns and manage any tax affairs related to the estate.
Applying for a TFN for the deceased estate involves completing the relevant application form and providing supporting documentation, such as the grant of probate or letters of administration. The TFN should be obtained as early as possible to ensure smooth administration of the deceased estate’s tax affairs.
Lodging tax returns for the deceased estate
The deceased estate may continue to generate income after the individual’s death, such as rental income from properties or interest income from investments. The executor or LPR is responsible for lodging tax returns on behalf of the deceased estate.
The tax return for the deceased estate should include all income earned by the estate during the financial year, as well as any deductions and offsets applicable to the estate’s expenses. It’s crucial to maintain accurate records and documentation to support the income and deductions claimed in the tax return.
Distribution of income to beneficiaries
During the administration of the deceased’s estate, income earned by the estate may be distributed to beneficiaries. The tax treatment of distributed income depends on the nature of the income and the beneficiary’s individual circumstances.
1. Interest and dividends
If the estate receives interest or dividend income, it may need to be included in the tax return for the deceased estate. However, when income is distributed to beneficiaries, they are generally assessed on that income in their personal tax returns. It’s important for beneficiaries to keep track of any income received from the estate to accurately report it in their tax returns.
2. Rental income
If the estate holds rental properties, the rental income earned should be included in the tax return for the deceased estate. However, when distributed to beneficiaries, the rental income will be assessed in their personal tax returns. Beneficiaries who receive rental income should be aware of their obligations to declare and report this income accordingly.
Distribution of assets and capital gains tax (CGT)
When assets are distributed to beneficiaries, potential capital gains tax (CGT) implications may arise. CGT applies to the difference between the market value of the assets at the time of the deceased’s death and the value when they are distributed to beneficiaries.
The CGT liability is generally borne by the deceased estate. However, beneficiaries may still have tax obligations if they subsequently dispose of the inherited assets. It’s crucial to consider the CGT implications before making decisions about selling or retaining inherited assets and to seek professional advice to optimize tax outcomes.
CGT event K3 addresses a situation where a taxpayer becomes deceased and a CGT asset that taxpayer owned passes to a beneficiary of the deceased estate, whereby the beneficiary is either:
- An exempt entity, or
- The trustee of a complying superannuation entity, or
- A foreign resident.
Essentially, what this CGT event is trying to achieve is to prevent CGT assets from exiting the CGT system without any tax consequence.
Estate planning considerations
Estate planning is a complex area which requires careful consideration of tax implications. Many issues that affect the distribution of assets to beneficiaries will need to be considered before an individual passes on to ensure undesirable tax consequences are avoided for both the individual and potential beneficiaries. These include the timing on the transfer of the assets including property and investments, potential gifts, transfer duties, and the use of testamentary trusts.
Typically in terms of capital gains tax (CGT), the transfer of assets upon the death of an individual does not immediately trigger a CGT event; rather, a CGT “rollover” applies. This means that the beneficiaries of the estate do not have to pay CGT at the time of inheritance. Instead, CGT implications are deferred until the beneficiary decides to dispose of the asset.
Generally, beneficiaries inherit the deceased’s assets at their market value as of the date of death for pre-CGT assets, and at the deceased’s cost base on the date of death for post-CGT assets. This then becomes the cost base for future CGT calculations when the asset is eventually sold. One important exemption to note is the main residence exemption, which can fully or partially shield the deceased’s primary home from CGT, provided certain conditions are met.
While gifts can be made as a part of estate planning before an individual passes, remember that if the gift is an asset (eg property, crypto assets, shares etc), CGT will still apply. For example, if an individual decides to gift a property to a relative before they pass on, the transaction would be the same as if the individual were selling the property. This means that CGT will apply but the main residence exemption (if available) would also apply to reduce the amount of CGT payable.
Another consideration in terms of the timing of transfers (in particular, of property) is the transfer duty involved at the State or Territory level. For example, in NSW, if property is received from a deceased estate in accordance with the terms of a will, the beneficiary will pay transfer duty at a concessional rate of $100. However, if the transfer occurs before an individual’s death or not in accordance with a will, normal rates of transfer duty will apply. In that scenario, it would be better to wait to transfer the property. The rules for each State and Territory differs so it is important to check the what the rules are.
For individuals looking to exert more control after their passing, a testamentary trust may be one way of providing a flexible and tax-efficient way to manage and distribute the assets of the estate to beneficiaries. Generally, the terms and conditions of the testamentary trust are outlined in the will of the deceased, including the appointment of trustees and beneficiaries and how the trust assets are to be managed and distributed. The trust itself comes into existence upon the death of the person making the will and is separate from the deceased estate for legal and tax purposes.
A testamentary trust offers tax benefits such as income distributed to minor beneficiaries being taxed at adult individual income tax rates and have a higher tax-free threshold. This only applies if they only receive excepted income or are an excepted person. A testamentary trust also has the added advantage of asset protection in that assets held within the trust are out of reach from claims by creditors, legal actions, and in some cases, family law disputes.
However, it should be noted that establishing and managing testamentary trusts can involve significant costs with the requirement to carefully draft the trust deed to include clear instructions for the establishment and operation of the testamentary trust to avoid future disputes. There may also be ongoing legal, accounting and administrative expenses, making testamentary trusts the most complex route to head down.
The specific tax implications can vary widely depending on individual circumstances and the State or Territory in which the individual lived. This is a complex area where seeking professional advice tailored to the situation is crucial, not only to save money on taxes, but also to ensure that significant issues are avoided in the future.
This article is general information only and does not provide advice to address your personal circumstances. To make an informed decision you should contact an appropriately qualified professional.