When Is an Estate Income Tax Return Required?

What Is a Deceased Estate Tax Return?

A deceased estate tax return is a trust tax return lodged by the executor (or, where there is no will, the administrator) for the estate as a trust. It is distinct from the deceased's own income tax returns. The estate return reports income earned by the estate's assets after the date of death, allowable deductions referable to that income, capital gains and losses on disposals during the administration period, franking credits, foreign income, and the way the net income of the estate is taxed — partly to beneficiaries who are presently entitled, partly to the trustee (executor) where it is not.

The estate is treated as a trust for income tax purposes under Division 6 of Part III of the Income Tax Assessment Act 1936 (Cth). The starting points are sections 97, 98, 99 and 99A, supplemented by the streaming rules, the CGT rules and the franking provisions. The return is lodged using the estate's own Tax File Number, not the deceased's personal TFN.

The Deceased's Final Return Versus the Estate Return

The two returns most often confused with one another are:

• the deceased's final personal income tax return (commonly called the 'date-of-death' return), which covers income earned by the deceased personally from 1 July of the year of death to the date of death — plus any prior-year returns the deceased had not lodged; and
• the estate's trust tax return, which covers income earned by the assets of the estate from the day after the date of death until the assets are transferred to the beneficiaries or otherwise dealt with.

The two returns are different taxpayers — the individual deceased on the one hand, and the estate as a trust on the other. They use different TFNs. They use different return forms. They have different rules on deductions, offsets and capital gains. They are lodged by the executor, but they are not the same document and they are not interchangeable. Our companion article on who pays tax on estate income in Australia covers the underlying section 97 / 98 / 99 / 99A framework in more detail.

When Is an Estate Income Tax Return Required?

As a general rule, an estate income tax return will be required for an income year where any of the following apply:

• the estate derives assessable income above the trustee tax-free threshold for the relevant year;
• tax has been withheld at source on estate income — for example, TFN withholding on bank interest credited before the estate TFN was provided, or pay-as-you-go withholding on payments received from a payer;
• the estate has realised a capital gain on the disposal of an asset during administration;
• the estate holds franking credits the executor wants to claim;
• the estate derives foreign income;
• the estate continues a business — even briefly — after the date of death;
• the estate has been issued with a return-not-necessary notice or a specific request to lodge by the ATO; or
• the executor proposes to stream income to a presently entitled beneficiary and needs to show that streaming on the estate return so the beneficiary can include the relevant amounts in their own return.

In practice, most estates that are large enough to require probate and that hold income-producing assets — bank accounts, shares, managed funds, rental property — for any meaningful period will need to lodge at least one estate return. The interaction between the trustee tax-free threshold, the concessional rates that apply to ordinary deceased estates in the early years of administration, and the harsher section 99A treatment once accumulated income falls outside the concessional window is the reason executors usually engage an accountant from the outset.

When Is an Estate Return Not Required?

An estate return is often not required where:

• the estate is small and contains only non-income-producing assets — for example, personal effects, a single residence sold within two years under the main residence exemption, and modest cash that is distributed promptly;
• no tax has been withheld on any payment received by the estate;
• the estate has not realised any capital gains and has no franking credits to claim;
• the estate has not continued a business; and
• the ATO has not issued a request to lodge.

In those cases, the executor may be able to lodge a return not necessary advice with the ATO rather than a full return. That advice is a short notification that explains why a return is not required for the relevant year. It should not be sent without specific accounting advice — sending a 'return not necessary' advice in a year in which one was in fact required can produce failure-to-lodge penalties and interest down the track. Where there is any doubt, the usual approach is to lodge the return.

The Estate Tax File Number

The estate's own TFN is the identifier the ATO, banks, share registries and fund managers use to attribute estate income to the correct taxpayer. The executor should apply for the estate TFN as soon as practicable after the date of death — ideally within weeks rather than months. Without it:

• banks may continue to withhold TFN amounts on interest credited to the estate;
• share registries may withhold on unfranked dividends;
• franking credits on dividends paid after the date of death can be missed or delayed; and
• the deceased's personal TFN may continue to receive income statements that properly belong to the estate.

The estate TFN is separate from the deceased's personal TFN and is the TFN used on every estate return lodged during the administration period.

Estate Income During Administration

Estate income is income derived by the assets of the estate after the date of death and before the residue is fully distributed. Typical sources are interest, dividends, distributions from managed funds and unit trusts, rent, partnership and trust distributions, and net business income where the estate continues a business briefly during administration. Each source has its own timing rule that determines whether the income belongs to the deceased's final return or to the estate return.

Interest Income

Interest credited up to the date of death is reported in the deceased's date-of-death return. Interest credited after the date of death is estate income and is reported in the estate return. Once the account is in the executor's name with an estate TFN, banks correctly report the interest to the estate. Until then, banks may withhold TFN amounts — which the estate later recovers by lodging the estate return. Notifying the bank of the death and providing the estate TFN quickly is the single most effective way to avoid unnecessary withholding.

Dividend Income

For listed shares, the cut-off is the dividend's record date. Dividends with a record date on or before the date of death belong to the deceased and are reported in the date-of-death return. Dividends with a record date after the date of death are estate income and are reported in the estate return. Franking credits attach to the dividend and follow it. If a beneficiary is presently entitled to the dividend, the dividend and franking credit are streamed to the beneficiary (subject to the streaming rules); otherwise the trustee is assessed and the franking credit is generally available to the trustee. Streaming the right franking credits to the right beneficiaries is one of the practical reasons to bring an accountant into the administration early.

Rental Income

Rent earned on estate-owned real property after the date of death is estate income. The estate claims the usual rental-property deductions — agent fees, council rates, insurance, repairs and interest on any inherited mortgage. Where the will gives a beneficiary a life interest in the property, that beneficiary is generally presently entitled to the rent and is taxed on it. Where the property is part of the residue and is held by the executor pending sale or transfer, the rent is estate income and is dealt with under the present-entitlement / trustee-assessment analysis.

Capital Gains Considerations

Death itself is not a CGT event. The key rules for executors are:

• when the executor sells a CGT asset during administration, normal CGT rules apply and any capital gain is included in the estate's net income;
• the cost base inherited from the deceased generally rolls over (with special rules for pre-CGT assets and the deceased's main residence);
• where a CGT asset is transferred in specie from the executor to a beneficiary, that transfer is generally a CGT roll-over and the beneficiary takes the cost base;
• the deceased's main residence can be sold without CGT within two years of the date of death if it was the deceased's main residence at the date of death and was not used to produce income during the relevant period — the Commissioner has a discretion to extend the two-year period; and
• capital gains made by the estate can be streamed to a beneficiary who is specifically entitled, with the CGT discount preserved subject to the streaming rules.

A capital gain almost always triggers an estate return obligation for the year in which it is realised, even where the estate is otherwise small and would not otherwise need to lodge.

TFNs for Deceased Estates

Applying for the estate TFN is straightforward — it is generally done by the accountant or by the executor through the ATO. The TFN should be put in place before estate accounts are converted into the executor's name so that the new account is opened with the estate TFN attached. Once the TFN is issued, the executor should update bank mandates, share registry records, managed-fund registers and any other payer of estate income.

Executor Obligations

From a tax point of view, the executor's obligations during the administration period include:

• notifying the ATO of the death and arranging the estate TFN;
• identifying every source of estate income;
• finalising the deceased's tax affairs — the date-of-death return and any outstanding prior-year returns;
• lodging the estate's trust tax return for each income year in which lodgement is required;
• issuing distribution statements to beneficiaries who are presently entitled;
• paying any tax assessed to the trustee;
• handling franking credits, foreign income and CGT events; and
• keeping records sufficient to support every position taken in the return.

The executor is personally liable for the proper administration of the estate, including the proper handling of its tax affairs. Our companion article on executor duties in Victoria sets out the broader duty framework. The basic process for obtaining probate is covered in probate in Victoria and (where there is no will) in letters of administration in Victoria.

Record Keeping

Good record keeping is the executor's single most useful tax-administration habit. The records that need to be kept include:

• statements of every bank account, share account and managed-fund account from the date of death;
• contract notes and settlement statements for every asset sale;
• the deceased's original purchase records for inherited CGT assets — cost base, improvement costs and acquisition dates;
• rental property records — agent statements, rates notices, insurance, repairs and any mortgage interest;
• distribution statements issued to beneficiaries;
• copies of every estate return lodged and every ATO assessment received; and
• working papers that explain how present entitlement, streaming and the section 99 / 99A analysis were applied.

CGT records should be kept for the life of the asset plus five years. Estate records generally should be retained for at least five years after the final distribution.

Beneficiary Distributions

For tax purposes, 'distribution' follows present entitlement, not the date a cheque is signed. A beneficiary can be presently entitled to income that has not yet been physically paid; conversely, an executor can advance cash to a beneficiary before that beneficiary is presently entitled. The two concepts have to be kept apart. The estate return shows the share of the net income to which each presently entitled beneficiary is entitled, and the beneficiary includes that share in their own return at their marginal rates. Beneficiaries who are unsure whether they are presently entitled — or whether the executor has streamed income correctly — should read our note on beneficiary rights during estate administration.

The Administration Period

The administration period runs from the date of death until the estate is fully administered — broadly, when assets have been collected, debts and taxes have been paid, and the residue has been ascertained so that the beneficiaries' shares are calculable. Once the residue is ascertained, residuary beneficiaries become presently entitled to estate income arising after that point. The length of the administration period is a question of fact and is rarely less than a few months for any estate that requires probate. Complex estates with business assets, disputes or significant tax issues can take a year or more.

Common Mistakes by Executors

The most common mistakes we see in estate tax administration are:

• failing to obtain an estate TFN early, which produces unnecessary withholding and missed franking credits;
• treating interest credited after the date of death as belonging to the deceased rather than the estate;
• missing franking credits on dividends with a post-death record date;
• accumulating estate income at year-end without considering whether to stream it — exposing the estate to section 99A treatment at the top marginal rate;
• lodging the deceased's final return without considering whether an estate return is also required;
• ignoring CGT obligations on asset sales during administration;
• failing to keep CGT cost base records for inherited assets;
• sending a 'return not necessary' advice in a year in which a return was in fact required;
• distributing the residue before the estate's tax position is finalised, leaving the executor personally exposed; and
• failing to coordinate with the deceased's accountant on prior-year returns and outstanding obligations.

Penalties and Risks

An executor who fails to lodge an estate return that was required can face:

• failure-to-lodge on time penalties;
• general interest charge on unpaid tax;
• shortfall penalties on amended assessments;
• section 99A treatment on accumulated income — top marginal rate plus Medicare levy;
• personal liability for tax paid out of the estate where the executor has distributed before the tax position is finalised; and
• reputational risk and potential challenge from beneficiaries who consider the estate has been mishandled.

The cost of accounting advice is small compared with the cost of getting the estate tax analysis wrong.

Working With Accountants

A tax-qualified accountant should be engaged early in the administration — ideally before the estate TFN is applied for. The accountant will coordinate the deceased's prior-year returns, the date-of-death return and the estate returns, advise on streaming, identify CGT and franking issues and prepare the distribution statements for presently entitled beneficiaries. The estate is entitled to deduct accounting fees referable to producing assessable income.

Where the estate holds a business, a private company or trust interest, foreign assets or significant CGT-heavy assets, specialist advice is essential — for example, our companion notes on what happens to a company when a director or shareholder dies and the death of a business owner in Victoria cover the additional steps required where the estate holds business assets.

When Legal Advice Should Be Obtained

Specialist estates legal advice should be obtained wherever the estate's tax position interacts with a legal question, including:

• where the will creates a testamentary trust — see testamentary trusts explained;
• where there is a dispute about who is presently entitled;
• where the estate holds shares in a private company, units in a trust, or business interests;
• where a beneficiary is under a legal disability (a minor or a person lacking capacity);
• where a TFM (family provision) claim has been threatened or commenced;
• where the executor proposes to distribute the residue before the estate return has been lodged and assessed; and
• where the administration period is likely to extend beyond a single income year.

How Parke Lawyers Can Help

We act for executors, beneficiaries, accountants and families across Australia on the legal aspects of estate administration that intersect with tax — ascertaining the residue, structuring distributions, establishing and funding testamentary trusts, handling company and trust interests in the estate, advising on the lodgement position for the estate return and resolving disputes about how estate income has been administered. Our services in these areas include probate and estate administration, wills and estate planning and commercial and business law.

This article is general information only. It is not taxation advice and it is not legal advice. Estate taxation is technical and depends on the facts of the individual estate. Executors and beneficiaries should obtain advice from a tax-qualified accountant and a specialist estates lawyer before lodging an estate return, deciding that lodgement is not required, or distributing estate income.

Frequently Asked Questions