Terminal Year

What Is Terminal Year?

A terminal year is a year in which an individual dies, in the context of estate planning and taxation. The term terminal year is used in estate planning and taxation because special tax rules and handling of income and assets may apply during the taxpayer's final year.

Understanding Terminal Year

The terminal year is considered for tax and estate handling purposes. The deceased will be subject to tax liabilities on any income earned or realized during the terminal year, similar to previous years of taxation. Certain deductions, income, and assets may receive special tax treatment during the terminal year, as part of the estate taxation process. In addition, certain tax forms are required to be filed for the terminal year of the decedent.

In Canada and the United States, for example, the surviving spouse, executor, or administrator of the estate must file a final return on behalf of the decedent.

Estate Taxes

In the United States, the estate tax, also commonly referred to as an inheritance tax or a death tax, is a financial levy on a beneficiary’s portion of an estate, usually on assets and other financial inheritances received by the estate’s heirs. This tax is not applied to assets transferred to a surviving spouse. Heirs or beneficiaries only pay this tax when the amount of the estate that they inherit is greater than the exclusion limit established by the Internal Revenue Service (IRS).

The application of estate tax varies and depends primarily on federal laws within the United States, but also partially on estate or inheritance tax laws in each state, and potentially on international law. Each state is responsible for establishing the percentage at which an estate is taxed at the state level, and states may offer additional exclusions to payment of estate taxes beyond the IRS exclusion limit.

Special Consideration

The freedom to transfer, or bequeath, assets from an estate to a living spouse is known as the unlimited marital deduction and can be done without any estate tax being levied. If the designated living spouse passes away, however, the beneficiaries of the remaining estate will likely be required to pay the estate tax on the total estate value that surpasses the exclusion limit.

In many instances, the effective U.S. estate tax rate is substantially lower than the top federal statutory rate of 37%. Estate taxes are owed only on the portion of an estate that exceeds the exclusion limit. To put this into perspective, consider an estate worth $7 million. With the set exclusion limit of $11.7 million, there would be zero estate taxes owed.

Even if someone that wealthy did owe estate tax, estate holders and beneficiaries, or their attorneys, continually find new and creative ways to protect portions of an estate’s remaining value from taxes by taking advantage of discounts, deductions, and loopholes.