Common misconceptions flagged with deceased estate taxes
Colonial First State has warned advisers on some of the common misconceptions around the taxation and Centrelink treatment of deceased estates and when taxes need to be paid by beneficiaries.
Speaking in a recent podcast, Colonial First State head of technical services Craig Day said that where a client passes away, it’s a common misconception that as long as the estate is kept open, then no beneficiaries need to pay tax and that the assets don’t count for Centrelink purposes.
“However, this is not the case,” Mr Day stated.
Once someone becomes the legal personal representative (LPR) for the deceased, one of the first obligations they will have is to lodge a final tax return for the deceased person, he explained.
CFS senior technical services manager Linda Bruce said the LPR would also need to lodge any tax returns that haven’t been lodged for previous financial years.
“After the date of death, the deceased estate might receive income or certain income will be paid to the deceased estate. The LPR is liable for to report that income in a deceased estate trust return,” explained Ms Bruce in the same podcast.
Ms Bruce said the LPR must use a deceased estate trust return to report income, claim deductions where applicable or claim tax returns for franking credits for the deceased estate.
“As long as the deceased estate is open, the LPR is required to check those details, make sure they report such income and check all the tax obligations before they make any final distribution. If they don’t, they could be personally liable for any tax owed by the deceased estate,” she cautioned.
During the period after death and before any of the beneficiaries become presently entitled, the trustee of the deceased estate will only have to pay tax marginal adult tax rates as long as the estate is administered within three years, explained Mr Day.
“If it goes longer than that, then different tax rates apply,” he said.
However, once the beneficiaries have present entitlement, they will have to start including that income that they are presently entitled to in their individual tax return, he said, unless they have a legal disability or they are a non-tax resident.
“We can’t just leave it in the estate and say ‘you beauty I don’t have to pay tax’, actually from present entitlement you do. If you’re a minor or someone that’s a non-tax resident, then the executor of the estate will actually have to pay tax on your behalf at adult tax rates,” he said.
In terms of determining whether someone is presently entitled, Ms Bruce said there are two key things that need to be looked at.
“The first one is whether or not the beneficiary of the deceased state has an indefeasible, absolutely vested interest in the income. That means that if the beneficiary has a claim or interest in the income, it cannot be defeated by another person. This may not be the case, if the trust or the estate has a potential dispute, then it’s questionable whether the claim or interest in the income can be defeated,” she explained.
“The second part is whether or not the beneficiary has the right to demand immediate payment of the income. This means the beneficiary can be presently entitled, even though they may not have actually received the income.”
Ms Bruce said the ATO has explained that whether a beneficiary is presently entitled can depend on what stage the administration of the deceased estate has reached.
There are three key stages in the administration of the estate, she noted.
“In the initial stage, which is the starting point of the deceased estate, the LPR could be really busy. They’re collecting assets, they’re collecting outstanding debts, they’re trying to determine whether or not the estate has enough assets or income to cover the deceased’s debts and they have to pay the funeral expenses or other testamentary expenses,” she stated.
“During that stage, it’s not possible for any beneficiary to be presently entitled to any of the income of the estate because even the LPR themselves don’t know whether the estate has enough assets or income to cover those expenses.”
In the intermediate stage, Ms Bruce said the LPR has identified whether there is enough net income to cover expenses and has the option to make an interim payment to eligible beneficiaries.
“If they do make the actual payment, that payment represents a share of the net income in the estate and [the beneficiary] would be regarded as presently entitled to that particular payment,” she noted.
The LPR may decide not to make any payment at that stage, however, in which case the ATO will not consider the beneficiaries to be presently entitled to the trust income as long as they don’t receive any payment, she explained.
“Once the final stage is reached, meaning the residue of the estate has been ascertained and all debts have been cleared, then the beneficiaries are presently entitled to the trustee income. Whether or not the LPR makes an actual distribution of that income, it does not matter. Once the administration is completed, the beneficiaries are presently entitled to the income derived by the estate,” she said.
“Once the beneficiaries are presently entitled to certain trust income, then that net income of the deceased estate will no longer be taxed at the estate tax rate; it will be taxed at the beneficiary’s marginal tax rate. [However], how the tax is collected and how the tax is paid can again be quite complicated depending on whether or not the beneficiary is under a legal disability, or whether the beneficiary is a tax resident or not.”
Ms Bruce noted that there are exceptions with certain types of income such as superannuation death benefits.
“Where the executor or the administrator of the deceased estate passes the super death benefit to a non-tax dependent through the estate, that’s a classic example where the taxable component is actually taxed in the hands of the LPR. It has nothing to do with the beneficiary. The beneficiary will receive the payment after the tax is taken. We’re talking about up to 15 per cent for the taxed element and up to 30 per cent for the untaxed element, payable by the LPR,” she noted.
In terms of the Centrelink rules, CFS senior manager technical services Kim Guest explained they work in a similar way to the tax rules in that Centrelink acknowledges that it will take some time to administer the date after someone passes away.
“So, while those assets are in the estate, and that person isn’t able to receive or hasn’t received their benefits from the estate, then they don’t assess it as the beneficiary’s assets yet,” said Ms Guest.
“However, if 12 months has gone by and you still haven’t told Centrelink that you have received or are able to receive your entitlement from the estate, then Centrelink will send out a letter and ask what’s happening and why you haven’t you received your entitlement from the estate. They will investigate whether something is preventing that from occurring.
“For example, if the client is the executor of the estate, and they have discretion as to when they can administer the estate, that might be one of the situations where Centrelink decides that they may be delaying the administration of the estate and that they might start assessing those assets.”
Miranda Brownlee is the deputy editor of SMSF Adviser, which is the leading source of news, strategy and educational content for professionals working in the SMSF sector.
Since joining the team in 2014, Miranda has been responsible for breaking some of the biggest superannuation stories in Australia, and has reported extensively on technical strategy and legislative updates.
Miranda also has broad business and financial services reporting experience, having written for titles including Investor Daily, ifa and Accountants Daily.