When Does a Deceased Estate End for Tax Purposes?

Why the Question Matters

The taxation of a deceased estate depends on who is treated as the taxpayer for each dollar of estate income and gain in a given year. Two people can be involved: the trustee of the estate (usually the executor) and each beneficiary. Which of them is assessed, and at what rate, turns on whether a beneficiary is presently entitled to the income, whether they are under a legal disability, and whether the Commissioner treats the trustee as taxable under section 99 or section 99A.

Getting the analysis wrong can lead to amended assessments, penalty tax under section 99A, or an unnecessary tax cost to a beneficiary. Getting it right is a matter of working through the applicable provisions and the facts, usually with tax-qualified accounting advice.

The Administration Period

The administration period is the period during which the executor collects the assets, pays the debts, calls in the estate and puts it in a position to distribute the residue. Its length depends on the assets, the complexity of the will, litigation, tax and duty matters, and the executor's diligence. There is no fixed statutory length for the administration period.

During administration, income derived from estate assets is generally income of the trust estate. The executor usually applies for a separate tax file number for the estate and lodges trust income tax returns for each relevant income year, in addition to arranging the deceased's date-of-death return.

The Present Entitlement Test

Under Division 6 of the ITAA 1936, income of a trust estate is generally taxed by reference to whether a beneficiary is presently entitled to trust income. A beneficiary is presently entitled where they have a vested and indefeasible interest in the income and can demand payment (subject to any legal disability such as minority).

While the residue of a deceased estate remains unascertained, a residuary beneficiary generally holds only an expectancy — the residue has not yet been identified — and is not presently entitled to residuary income. This is the general law principle applied in deceased-estate contexts and reflected in IT 2622. Present entitlement to specific gifts of income (for example, a legacy of the income of a particular asset) may arise earlier depending on the terms of the will.

Section 97, 98, 99 and 99A

Once present entitlement, disability and residency have been identified, the tax treatment falls into one of the main Division 6 provisions:

• Section 97 — a resident beneficiary who is presently entitled and not under a legal disability is generally assessed on their share of the trust's net income.
• Section 98 — the trustee is assessed on a share of the trust's net income to which a presently entitled beneficiary is entitled where that beneficiary is under a legal disability, is a non- resident, or in other specified circumstances.
• Section 99 — where no beneficiary is presently entitled to income (or an amount is accumulated) and the Commissioner is of the opinion that section 99A should not apply, the trustee is assessed at rates equivalent to a resident individual, which for a deceased estate can produce a materially lower tax cost than section 99A.
• Section 99A — in the residual case, the trustee is assessed at the top marginal rate plus Medicare on the relevant income.

IT 2622 and the Administration Period

Taxation Ruling IT 2622 sets out the Commissioner's approach to income of a deceased estate during administration. The ruling distinguishes three broad phases: an initial period during which beneficiaries are unlikely to be presently entitled; an intermediate period in which the executor may be in a position to make interim distributions of income to beneficiaries; and the period after full administration, once the residue has been ascertained.

For income of the first three income years of the estate, the ATO's stated practice is generally to apply section 99 rather than section 99A where the estate is being administered in good faith. That is the Commissioner's practice — not a statutory concession — and does not preclude the section 99A analysis being reconsidered on the facts of a particular estate, particularly where administration is prolonged. IT 2622 also recognises that the executor may make interim distributions to beneficiaries during administration in appropriate cases; whether those distributions carry present entitlement to the underlying income for tax purposes is a matter of fact and law.

When the Residue Is Ascertained

The residue is generally ascertained when the assets have been collected, debts, funeral and testamentary expenses, tax and any pecuniary legacies have been paid or properly provided for, and the estate is ready to be distributed in accordance with the will (or the intestacy rules). Ascertainment is a question of fact and general law that depends on the circumstances of the estate.

Once the residue is ascertained, the residuary beneficiaries generally have a vested interest in the residue and can become presently entitled to income derived from residuary assets. Income arising after that point is generally taxed under section 97 in the beneficiaries' hands (or under section 98 where relevant), rather than in the hands of the trustee.

Executor's Continuing Role After Administration

After administration, the executor may still hold registered title to particular assets pending transfer, sale or the establishment of a testamentary trust. The character in which the executor holds those assets is a question of general law. In some cases the executor holds an asset on a bare trust for the beneficiary; in others the executor continues to hold as trustee of the testamentary provisions of the will. The tax treatment of income and gains from those assets follows that characterisation, subject to Division 6 and the CGT rules.

Testamentary Trusts

Where the will creates a testamentary trust, the testamentary trust is a separate trust that continues after the estate itself has been fully administered. Once the residue is ascertained and the trustee holds assets on the terms of the testamentary trust, income and gains from those assets are taxed under the rules that apply to the testamentary trust, subject to Division 6 and the excepted trust income rules in section 102AG of the ITAA 1936 for eligible minor beneficiaries.

Capital Gains and Division 128

Section 128-15 of the Income Tax Assessment Act 1997 (Cth) generally disregards a CGT event where an asset the deceased owned just before death passes to their legal personal representative or a beneficiary. Whether an asset 'passes' to a beneficiary for these purposes is defined in section 128-20. Assets acquired by the estate after death, and gains arising on later sales, are dealt with under the ordinary CGT rules. Streaming of capital gains and franked distributions to beneficiaries is subject to Subdivision 115-C and Subdivision 207-B of the ITAA 1997.

Litigation and Delay

Where administration is delayed by litigation — including a family provision claim under Part IV of the Administration and Probate Act 1958 (Vic), a probate caveat or a dispute about the validity of the will — the residue cannot generally be ascertained until the litigation is resolved or compromised. During that period the trustee is assessed on retained income under section 99 or section 99A on the facts. See our companion article on distribution before tax is finalised for the executor's protection considerations.

Non-Resident Beneficiaries and Withholding

Where a presently entitled beneficiary is a non-resident, special rules apply, including trustee assessment under section 98 and withholding obligations on particular categories of income. Non-resident beneficiary issues should be addressed with a tax adviser before any distribution is made.

Practical Steps

• Obtain a tax file number for the estate before it derives assessable income.
• Keep a clear record of the assets, liabilities, expenses and income of the estate on a year-by-year basis.
• Identify when the residue is likely to be ascertained and document the basis for that view.
• Take accounting advice before lodging the first return, before switching reporting to beneficiaries, and before any interim or final distribution.
• Take legal advice on complex issues such as testamentary trusts, business or pre-CGT assets, non-resident beneficiaries and pending litigation.

For general estate administration guidance, see executor duties in Victoria and probate in Victoria. For the interaction with a testamentary trust, see taxation of testamentary trusts.

Frequently Asked Questions

How Parke Lawyers Can Help

We act for executors, beneficiaries, accountants and testamentary trustees on the tax treatment of deceased estates — present entitlement, Division 128 rollover, testamentary trust taxation and the point at which the estate ends for tax purposes — through our Probate & Estate Administration team. Engage us early so returns, distributions and any elections are coordinated properly.