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?

The ATO applies different filing tests to a deceased estate depending on the stage of administration. In the first three income years after death, a trust return is required for the estate for an income year where any of the following apply:

• the estate's net income for the year exceeds the individual tax-free threshold for a resident individual;
• a beneficiary is presently entitled to any of the estate's income at the end of the year; or
• a beneficiary is not an Australian resident.

From the fourth income year of administration onwards, the test is materially stricter: a trust return is required if the estate earns any income during the year, including a capital gain.

Independently of those tests, a return may be lodged voluntarily — for example, to recover tax withheld at source (such as TFN withholding on bank interest or PAYG withholding) or to claim surplus franking credits — and the executor should separately comply with any specific ATO request to lodge for the year. Withholding and franking credits do not, of themselves, create an ordinary compulsory lodgement obligation. Always confirm the position against the ATO's current published guidance for the relevant year.

When Is an Estate Return Not Required?

In the first three income years of administration, no trust return is required where all of these apply:

• the estate's net income does not exceed the individual tax-free threshold;
• no beneficiary is presently entitled to any estate income at the end of the year; and
• every beneficiary is an Australian resident.

Even where a return is not compulsory, lodging a voluntary return can be sensible — for example, to recover tax withheld at source or to claim surplus franking credits. If in doubt, confirm the position with the estate's accountant against the ATO's current tests before treating the year as a 'no lodgement' year.

The Estate Tax File Number

Where the estate is required (or the executor elects) to lodge a trust return, the estate needs its own TFN as the identifier the ATO, banks, share registries and fund managers use to attribute estate income to the correct taxpayer. The estate additionally needs an ABN if it is carrying on a business. Not every estate needs a TFN immediately — the requirement follows the need to lodge. Where a TFN will be needed, applying early can also help avoid unnecessary withholding, because without it:

• banks may 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. Where an estate TFN is needed, notifying the bank of the death and providing the estate TFN can help reduce unnecessary no-TFN withholding.

Dividend Income

Whether a particular dividend is derived by the deceased (and reported in the date-of-death return) or by the estate (and reported in the estate return) turns on the applicable dividend and tax rules; the record date alone is not a universal tax-allocation rule. 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;
• failing to apply the relevant dividend/derivation and present-entitlement rules to dividends received during administration — record date alone is not a universal tax-allocation rule;
• accumulating estate income at year-end without considering whether a beneficiary should be made presently entitled — exposing the estate to trustee assessment under section 99 or 99A depending on the stage of administration and the facts;
• lodging the deceased's final personal return without separately considering whether an estate trust return is also required;
• ignoring CGT obligations on asset sales during administration;
• failing to keep CGT cost base records for inherited assets;
• treating an income year as a 'no lodgement' year without checking the ATO's filing tests for that year;
• distributing the residue before the estate's tax position is understood, which may expose the executor personally under section 254 ITAA 1936 to the extent of estate assets held or that should have been held; 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;
• trustee assessment under section 99 or 99A on accumulated income — with section 99A potentially applying the top marginal rate depending on the facts;
• personal liability under section 254 ITAA 1936, qualified by the tax liability, notice or knowledge of the assessment and the value of estate assets held or that should have been held; 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