Reporting Executor or Fiduciary Taxes
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When an executor or fiduciary is compensated for his or her work, this is considered taxable income. As such, there are specific requirements related to reporting this income on his or her taxes.
The income received as compensation as a fiduciary or executor goes under the heading “other income” on Line 21 on Form 1040. For example, if you earned $20,000 as an executor, you fill in $20,000 on Line 21 by the line named “Other Income.”
Typically, this income is not subject to self-employment tax. An exception is if the executor ran a business that was part of the estate. Another exception is if the executor or fiduciary routinely handles estates. Therefore, if serving as an executor was a one-time occurrence and you were not actively participating in a business owned by the estate, you are most likely not subject to self-employment tax. Publication 559 discusses the requirement of listing fiduciary or executor income in more detail.
Importance of Self-Employment Tax Information
It is critical to know whether you will be classified as self-employed. This is because being self-employed carries a larger tax burden. When you work directly for an employer, your employer is usually responsible for withholding the proper amount of federal taxes, state taxes and potentially local taxes. Additionally, an employer withholds taxes for Social Security and Medicare, known as the FICA tax. If an employee indicated the proper amount of deductions and the employer withhold the proper amount of taxes, the employee usually will not owe taxes when filing his or her annual tax return.
In addition to transferring the employee’s FICA taxes to the government, the employer is also responsible for paying an equal rate for the employee. In 2016, the employee and employer rate was 7.65 percent, making a total of 15.3 percent paid to the government. This rate is applied up to a certain max income as established by law.
When an individual is self-employed, he or she does not have an employer who is making the 7.65 percent contribution. Additionally, no one is withholding taxes on behalf of the individual. Therefore, the employee is usually required to make quarterly estimated payments for applicable federal, state and local taxes. Additionally, the employee is responsible for the entire 15.3 percent for FICA taxes. However, the self-employed individual can deduct 7.65 percent of the self-employment tax by including the deduction on Line 27 of Form 1040 on the line named “One-half of self-employment tax.”
If the executor received $20,000 in pay and was taxed at a federal tax rate of 20 percent, his or her tax liability on this amount would be $4,000. However, if the executor’s income was considered self-employment income, the individual would still have the initial tax liability of $4,000 from the income. He or she would also have an additional $2,800 of tax due to the self-employment tax.
Sometimes an executor may receive a notice from the Internal Revenue Service that states that he or she owes an additional amount of tax, such as $2,800. This is because the IRS may mistakenly believe that the executor’s income was from operating a business because the income is listed under “Other Income.” The executor’s first action may be to call the phone number listed on the IRS notice and explain to the representative the source of the income. He or she may explain that the income was from acting as an executor and that he or she was not actively participating in a business and is not in the routine business of serving as an executor. The representative may ask for the executor to provide evidence of the source of income. Such evidence may be from documentation from the probate court or from cancelled checks that indicate payment to the executor from the estate.
If this notice arrives years after the executor’s work has been performed, he or she may no longer have personal documentation that establishes the source of income. However, he or she can ask the probate court for documentation in its records that show the source of income. When the executor submits this evidence, he or she may also state that he or she is not subject to self-employment tax.
If this does not resolve the problem, an executor or fiduciary may wish to consult with a tax attorney who can advise him or her on how to resolve the dispute.
Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer.