Final Tax Return Affords Tax Planning Opportunities

Photo by patpitchaya/iStock / Getty Images
Photo by patpitchaya/iStock / Getty Images

Most professional advisors are attuned to the various tax planning strategies available during their clients’ lifetime. However, some may overlook the importance of thoughtful planning and discussing such strategies with elderly clients or those nearing death.  Although this may be a difficult and emotional time for the client and their family, proper planning can result in significant tax savings.

Areas that lend themselves to planning opportunities include, but are not limited to:  passive activity losses; capital loss carryovers; and net operating losses. It is important to recognize if such tax attributes exist to allow for adequate time to implement strategies and take full advantage of the potential tax savings.

Suspended passive activity losses are allowed on a decedent’s final income tax return, subject to certain limitations.  If any losses remain after applying these limitations, they are permanently lost as a tax deduction. However, there may be cases where the property giving rise to the loss has declined in value. In this situation, it may be beneficial to gift the property so that the higher donor basis would be assumed rather than the lower stepped-down basis in the hands of the heirs. This lower basis would result in a larger tax liability upon sale of the property.

Another type of loss to consider are capital losses. Tax law states that capital loss carryovers expire upon the death of a taxpayer and cannot be carried forward and used by the surviving spouse or on the estate income tax return. Therefore, if capital losses exist for a taxpayer approaching death, opportunities to generate capital gains should be pursued. Note that a surviving spouse can continue to generate capital gains for the remainder of the year after the taxpayer’s death to offset the decedent’s capital loss carryovers on the final joint return.

Similarly, net operating losses (NOLs) of a decedent cannot be deducted on the federal estate tax return or by the surviving spouse on future income tax returns. NOLs should be evaluated to determine if any amount can be attributed to the surviving spouse which would allow for carryforward.  If not, the surviving spouse has a window of opportunity, from the date of death to the end of the tax year, to generate additional income that can be used to offset the decedent’s NOL on the final joint return. In this case, the surviving spouse should also consider delaying any tax deductions.

The above tax attributes highlight some of the areas that need to be considered as clients age and approach death.  Although such discussions may be difficult, there is potential for significant tax savings to both the client and their heirs.


Connie Farell, CPA