When you lose a loved one, taxes are probably the last thing on your mind. However, as things settle down and you get to the details of closing up the decedent's financial life, you need to know how to report the interest earned on the decedent's accounts. Who pays taxes on that interest depends on when the interest was earned.
Pre-Death Interest
The interest earned on the decedent's accounts before dying gets reported on the decedent's final income tax return and taxed like it was earned by the decedent. For example, say someone dies halfway through the calendar year and has earned $300 of interest on a savings account from January 1 until the date of death. That $300 must be included in the decedent's final income tax return.
Final Income Tax Return
Taxes follow you even beyond the grave. Just because someone dies doesn't mean her income for the year goes untaxed. Instead, the personal representative of the decedent is responsible for filing an income tax return for any income earned by the decedent during that calendar year. This includes not only interest income, but also other income like wages, bonuses, capital gains and self-employment earned before dying.
After-Death Interest
As soon as the person dies, the account becomes property of the decedent's estate. As a result, any interest earned after the decedent's death must be included in the estate tax return. However, if the estate pays that interest out to the beneficiary, the beneficiary includes that interest on his income tax return. For example, say your mom died in June and named you as the beneficiary of her savings account. If the account, including the interest earned, is transferred to you in August, and the account earned $30 in interest between the date she died and the date of transfer to you, that $30 of interest is taxable to you.
Splitting Up Interest
Sometimes, banks or other interest payers won't know that a decedent has died and will report all of the interest on the account on one Form 1099-INT. For example, if your father dies in November, the bank might just send one1099-INT in his name that covers the entire year. In that case, you divide the interest between your father's final return and either the estate tax return or the person who gets paid the interest when the account is disbursed. The entire amount is reported on your father's return on Schedule B, and then the amount properly attributable to the estate or beneficiary is subtracted. The decedent's estate should give a Form 1099-INT to the person who is responsible for a portion of the income.
