A surviving spouse will have many tax-related issues to deal with upon the death of their spouse. They may have to file an Estate tax return which includes gathering asset and debt related information. They may work with an attorney for probate of the Estate or transfer of Estate assets. One item that may be overlooked but could cause a great headache during the individual income tax preparation of the spouse is related to tax carryovers – including net operating losses, capital losses and charitable contributions. What should be done with them in the year of death? Who owns them in the subsequent year of death? These questions will help determine the proper completion of the surviving spouse tax return including the proper deduction of them.

In the simplest terms, carryovers can be included on the decedent’s final income tax return but are generally lost on subsequent income tax returns. This is a rather easy situation for a single taxpayer. What is not used on the final income tax return will simply go away. It is a bit more difficult for joint filers. In the year of death, any carryovers are still available to both spouses even to offset income after the date of death or earned by the surviving spouse. The tax carryovers need to be examined carefully in subsequent tax years, as carryovers attributable to the decedent are not available to be transferred to the surviving spouse.

As mentioned above, three main tax carryovers that joint filers may have in the year of death are net operating losses, capital losses, and charitable contributions. The tax treatment of each will be discussed below.

1. Net Operating Losses

Revenue Ruling 74-175 helps to address this issue. The Revenue Ruling indicates that only the taxpayer who sustains the loss is entitled to take the deduction. Thus, the loss cannot be transferred to another taxpayer including the surviving spouse. The net operating loss will need to be traced to the business interest that created it. If owned by the decedent, then the loss is only available on the final income tax return. Any amount not completely used will be lost on subsequent income tax returns filed by the surviving spouse.

2. Capital Loss Carryovers

Similar to net operating losses, Revenue Ruling 74-175 helps to address this issue. Only the taxpayer who sustains the loss is entitled to take the deduction. Thus, sales of capital assets will require a tracing to the original owner in order to determine who is entitled to the capital loss carryover. If the decedent, then the loss is only available on the final income tax return. If the surviving spouse, then the loss can be carried forward to subsequent income tax returns.

3. Charitable Contribution Carryovers

Charitable contribution carryovers allocated to the decedent will also be lost upon the death of the taxpayer if not used on the final income tax return. IRC Regulation Section 1.170A-10(d)(4)(i) addresses charitable contribution carryovers upon the death of a spouse. Per the regulations, a joint filer’s original charitable contribution must be recomputed as if two separate income tax returns were filed and not a joint tax return for the year of contribution. Any amount allocable to the decedent is lost on a subsequent income tax return filed by the surviving spouse.

The death of a spouse can certainly be traumatic and life-changing. It can also bring some significant difficulties when preparing the final income tax return for the decedent as well as the subsequent income tax returns for the surviving spouse. Making sure you can properly allocate any current tax carryovers to each respective spouse can help alleviate some difficulties down the road. Proper understanding of the tax treatment of tax carryovers at death can also help the surviving spouse not be blindsided by an unexpected tax situation due to loss of some portion if not all of a tax loss carryover. We as professionals can hopefully make a hard time a bit easier for the surviving spouse by having these discussions now and preparing any necessary loss allocations in order to determine which spouse is entitled to them.

Content provided by LBMC tax professional Ben Alexander.

LBMC tax tips are provided as an informational and educational service for clients and friends of the firm. The communication is high-level and should not be considered as legal or tax advice to take any specific action. Individuals should consult with their personal tax or legal advisors before making any tax or legal-related decisions. In addition, the information and data presented are based on sources believed to be reliable, but we do not guarantee their accuracy or completeness. The information is current as of the date indicated and is subject to change without notice.