Tax-paying entities must associate their tax returns with a unique identifier, such as a tax ID or Employer Identification Number (EIN), when filing their returns. In the case of individuals, this is usually their Social Security Number (SSN), but organizations typically use an EIN. This guide explores how tax IDs and EINs work and why you need one to settle an estate.
Overview
Business owners typically separate their business and personal assets when filing taxes to both limit personal liability for business debts and minimize ambiguity about which assets belong to which entity. This process generally involves obtaining an EIN for the business, which owners use to hire employees, obtain business loans, and complete other activities they can’t accomplish with their SSN. Business owners also use a unique EIN for each business, ensuring their assets remain separate.
Estates
An estate is the collection of a decedent’s assets, which may include the following:
- Artwork
- Bank accounts
- Cash
- Collectibles
- Furniture
- Land
- Real estate
The decedent often conducts estate planning before their death, which consists of developing a detailed road map for the disposition of their estate. This road map includes the will, along with any trusts and powers of attorney needed to settle the estate. This process involves satisfying debts and filing income taxes for the estate. The decedent may also appoint an individual, such as an executor or administrator, to distribute assets according to their wishes.
Differences between an Estate and a Trust
The first step in estate planning is to determine the method to use in handling assets to ensure the decedent’s affairs are in order. The two most common approaches are an estate and a trust. These legal structures are distinct, although people often use these terms interchangeably. The purpose of both structures is to transfer assets from the estate to its heirs and beneficiaries, but they differ sharply in the way that the planner manages those assets. It’s, therefore, essential for estate planners to understand the differences in asset distribution between estates and trusts.
Estates
An estate is a temporary legal structure designed to transfer a decedent’s assets once, after which the estate is settled. The decedent’s last will and testament provide directives that carry out the decedent’s final wishes. A decedent who dies without a will is said to have died intestate, requiring the state to determine how to distribute the estate’s assets.
State laws typically specify this process, which generally requires the estate to first settle any debts and liabilities. Next, the beneficiaries receive assets in the order specified by state law. This process typically distributes assets to the spouse first, followed by blood relations in descending order of closeness.
An estate only includes assets owned solely by the decedent, not joint assets shared with another person. Assume for this example that a married couple jointly owns a house when one spouse dies. In this case, the surviving spouse keeps the house, which is excluded from the estate. The estate is then dissolved after its executor distributes all of its assets.
Trusts
Anyone who owns assets can establish a trust for their assets. This legal entity can be revocable or irrevocable based on the owner’s particular needs. For example, they can change or revoke a revocable trust at any time. On the other hand, an irrevocable trust must adhere to its original terms, as it can’t be amended later. A person can also use a trust to distribute their assets before or after their death, depending on its terms.
The creator of a trust must select a person to manage the trust, commonly known as a trustee. The trustee is usually someone the creator knows well, such as a friend, family member, or attorney.
While an estate settlement must satisfy the owner’s debts and liabilities before distributing assets, this isn’t the case with trusts. In addition, a trust is never part of the decedent’s estate and is exempt from any probate proceedings in which a court decides how it will distribute the estate’s assets. Furthermore, an estate still remains a legal entity after its owner passes away, even if it wasn’t planned. The primary difference between a planned and unplanned estate is that estate planning allows the individual to specify the executor’s management of those assets. In comparison, an unplanned estate typically requires a court to execute it.
A trust may include specific terms regarding the disposition of the creator’s assets. For example, it may require the beneficiary to reach a certain age before the trust will distribute any assets to them. Another common use of trusts is to require the beneficiary to use assets only for specified purposes, such as education.
Requirement for a Tax ID or EIN
The executor of an estate will usually need to file a tax return for it, like other legal entities with assets. This process will require the executor to obtain an EIN for it since an estate can’t use the decedent’s SSN. The reason for this requirement is to separate the decedent’s personal income taxes from the taxes on their estate. As of 2024, estates in the United States will owe income tax when they generate over $600 in gross income in a year. Assets that become the estate’s property upon the owner’s death include the following:
- Certificates of deposit (CDs)
- Mutual funds
- Rental property
- Savings accounts
- Stocks and bonds
All the above assets generate income, which could make estates with these assets subject to income tax. In these cases, the estate will need its own tax ID that’s different from the decedent’s tax ID. Thus, the executor of the estate will need to obtain an EIN for the estate if it doesn’t already have one.
Apply for an EIN
The most common way to obtain an EID for an estate is to file a form SS-4 entitled “Application for Employer Identification Number.” Filing methods include online, mail, fax, and professional assistance. This form requires you to provide information on both the decedent and the decedent’s representative, who may be an executor or administrator or personal representative. It also requires information on the estate itself.
Decedent Information
The primary information about the decedent on an SS-4 is their name, including first and last name with middle name as an option. This name must exactly match the decedent’s name on file for the Internal Revenue Service (IRS) and the Social Security Administration (SSA).
Representative Information
An SS-4 must contain the name of the person who will handle the decedent’s estate, including their first and last name, with a middle name as an option. It also requires the representative’s complete residential address, including street number, apartment number (if any), city, zip code, state, and country. This address can be a legal street address, or a post office box. In addition, the SS-4 must include the representative’s SSN.
Estate Information
An SS-4 must contain information on the estate, such as the date it was created and funded. In cases where you need to change the estate’s address of record, you can submit Form 8822, entitled “Change of Address (for Individual, Gift, Estate, or Generation-Skipping Transfer Tax Returns).” The processing time for changing the estate’s address can be as long as six weeks.
Open a Bank Account
An executor will often need to open a temporary bank account on behalf of the estate. The funds in this account empower the executor to pay the estate’s ongoing expenses in addition to the final distribution of funds to beneficiaries, whether they’re named by the decedent or mandated by the probate court. Additionally, the estate’s account should only contain money that belongs to the estate.
The estate planner may establish an account for the estate before their death to facilitate the executor’s ability to conduct the estate’s business. The estate planner can open a joint account with the executor while they’re still alive, but it’s normally better to maintain separate accounts for the estate planner and executor. For example, a standalone account makes it easier to ensure that estate funds aren’t misused accidentally or intentionally for inappropriate purposes.
In the event that the estate planner hasn’t already set up a bank account for the estate prior to the decedent’s death, the executor should take the following steps:
- Initiate the probate process before opening the account to establish the reason for doing so.
- Open the account in the decedent’s legal state of residence. This step avoids complications such as paying taxes on the estate to two states.
- Obtain an EIN for the estate.
- Bring any documentation the bank needs to open an account for an estate. In addition to the EIN, the bank will need other records, such as a directive appointing the executor, a copy of the will or trust, and a copy of the decedent’s death certificate.
- Complete the forms needed to open the account.
- In most cases, you will also make an initial deposit to fund the account.
If the estate goes into probate, the court will need to complete that process before the executor can distribute the remaining assets to the estate’s beneficiaries. Once all the distributions have been made, the executor should close the estate’s bank account.