The taxation of deceased estates can be easy and it can be tricky. It depends on what goes in, what happens while it is in there and how it leaves.
Taxation of Deceased Estates
The first question is what goes into your estate. The next question is how to tax your estate.
The taxation of deceased estates faces two tax implications: Income tax and capital gains tax.
Income Tax
Income tax applies while the deceased estate holds the assets and these earn income within the estate. The question is who pays income tax on what income at what marginal tax rate?
In a normal discretionary trust there is time pressure. You need to distribute all income to beneficiaries as of 30 June. Otherwise, the trustee pays tax at the top marginal tax rate under s99A ITAA36.
However, in a deceased estate you don’t have that pressure. You just leave the income with the trustee while they are sorting out the estate.
And the trustee pays tax on the income at normal individual income tax rates under s99 ITAA36. At least for the first three years. After that a special tax rate table applies to the estate. But even that is still far from the draconian s99A.
Capital Gains Tax
When the owner of a CGT asset dies, the right to that asset vests in the deceased’s legal personal representative (LPR) at the time of death. This change in ownership is a CGT event. The decased has a cost base for that asset and is deemed to receive market value under the market value substitution rules. So that would mean a capital gain or loss. If there wasn’t Division 128 ITAA97.
Under s128-15 any capital gain or loss that arises from the asset passing from the deased via the LPR to a beneficiary is disregarded unless it goes to a tax-exempt entity like a charity or foreign resident.
s128 – 15 (1): This section sets out what happens if a CGT asset you owned just before dying:
(a) devolves to your legal personal representative; or
(b) passes to a beneficiary in your estate.
(2) The legal personal representative, or beneficiary, is taken to have acquired the asset on the day you died.
(3) Any capital gain or capital loss the legal personal representative makes if the asset passes to a beneficiary in your estate is disregarded.
So when you die, your assets are taken to have been acquired by the legal personal representative or beneficiary on the date of your death. And any capital gain or loss that arises is disregarded per s 128 ITAA97. But this provision only applies to assets you owned at the date of death.
Cost Base
But what cost base do the beneficiaries now have for this asset?
In the normal case scenario the beneficiaries receive the asset with the deceased’s cost base. But there are some exceptions.
One exception is if the asset is a pre-CGT asset. In that case the beneficiaries are deemed to have acquired the asset for the asset’s market value at the time of death. So the market value is their new cost base and the asset is no longer pre-CGT.
Another excpetion is if the asset was the deceased’s main residence. In that case the beneficiaries are also deemed to have acquired the asset at market value at the time of death. So market value is their cost base.
Testamentary trusts
Division 6AA contains onerous rules that require a minor’s income to be taxed at penalty rates. However, there are exceptions to this rule. And the main one is s102AG(2)(a) of ITAA36 . This one provides that income will be excepted trust income where the income is assessable income of trust estate that resulted from a will or codicil.
This means that trusts established under a will for the benefit of minor beneficiaries are outside the application of Div 6AA. Income derived by the minor beneficiaries of the testamentary trust will get the benefit of the full tax threshold and the ordinary marginal rates.
Example
Bob executes a will leaving his estate (valued at his death at $5m) in trust for his daughter and her two children in equal shares. Assume $54,000 is earned each year. Also assume that none of the beneficiaries has income from other sources.
His daughter and her two children will each receive $18,000 tax-free each year and therefore no tax will be paid on the $54,000 income.
MORE
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Super is Not Part of Your Estate
Disclaimer: Tax Talks does not provide financial or tax advice. All information on Tax Talks is of a general nature only and might no longer be up to date or correct. You should seek professional accredited tax and financial advice when considering whether the information is suitable to your or your client’s circumstances.
Last Updated on 23 March 2020
