The loss of a spouse has been described to me by clients as “all-encompassing grief” and “an indescribable emotional, physical, and mental fatigue.” For those who have experienced a significant loss recently, the burden of financial decision-making may feel like a weight added to an already heavy load.
Statistically speaking, men in heterosexual marriages tend to self-identify as the more knowledgeable partner when it comes to household finances. The year of a spouse’s death is particularly stressful for the widow who finds herself in a new role as the sole financial decision-maker. Even if she was previously the more financially savvy partner, the specific financial decisions following the death of a spouse can overwhelm even the most adept person.
Here are the answers to three tax questions clients frequently ask me upon losing a spouse:
Can I continue to use the married filing jointly status in the year my spouse passes away?
The ‘married filing jointly’ status is advantageous because the IRS allows widows and widowers (who have not remarried) to continue using it in the year of the spouse’s death, regardless of whether they passed away on January 1 or December 31.
For most people in retirement, there are no longer any dependent children to claim on taxes. If you do have dependent children, there are additional rules, and filing as a Qualifying Widow(er) may make sense. Let’s look at an example of a change in filing status for a recently widowed retiree with no dependents.
Example
Jane’s husband, Bob, passed away on September 1, 2024. When Jane files her taxes in April 2025, she will use the married filing jointly status and retain the higher standard deduction amount of $29,200 for 2024, among other benefits.
During the 2025 tax return filing (due in April 2026), Jane may no longer use the married filing jointly status if she remains single and does not remarry in 2025. The year of the single filing status, 2025, may create significant tax implications for Jane if her retirement income is about the same as in 2024 when she filed a joint return with her husband.
This increase in taxes is appropriately named “the widow’s penalty.”
How are taxes impacted by downsizing my primary residence?
The IRS allows for an exclusion of gain ($250,000 single, $500,000 married filing jointly) when selling a primary residence. Typically, you are eligible for the exclusion if you owned your home and lived in it regularly for at least 2 years out of the previous 5 years before the sale.
For widows(ers) who don’t meet the two-year requirement, the $500,000 exclusion amount is still available if you sell the home within two years (24 months, not two tax years) of the death of a spouse and have not remarried. Your spouse needed to live in and own the home for at least two years. If your spouse used the exclusion for a previous home sale in the last two years, you would be disqualified from using the higher exclusion amount of $500,000.
In most states, when a married couple buys property jointly, they effectively share ownership of the property. When your spouse dies, the jointly owned property is now owned by you. In general, the IRS taxes property that is sold at a gain from the original purchase price. The bigger the gain, the higher the potential tax bill.
When a spouse dies, the surviving spouse receives a half-step up in basis. In other words, the gain from the sale of property hurts a bit less when it comes to potential taxes if there is an increase in the cost basis. Let’s look at some examples.
Example 1:
Ann’s husband, Luke, passed away on June 15, 2020. Ann and Luke owned their home jointly, and they originally bought the home in 1975 for $50,000. Home values in their neighborhood soared in recent years, and the 4,000 square foot home plus acreage is too much upkeep for Ann. She decided to sell the home on May 1, 2022 and has a buyer willing to pay $725,000. Ann has no plans to remarry.
Following Luke’s death, Ann’s cost basis was stepped up to $387,500 (half of the original purchase price of $25,000 plus half of the sale price of $362,500). Ann’s gain on the sale will be $337,500 (sale price of $725,000 minus stepped-up basis of $387,500). Ann’s proceeds fall under the exclusion amount of $500,000, and she will not likely need to pay capital gains tax as a result of the sale.
Example 2:
Let’s say Ann had waited until November 1, 2022, to sell her home (over 24 months since Luke’s death). Ann no longer qualifies for the $500,000 exclusion amount and only has $250,000 in primary residence sale exclusion available due to her single filing status.
In this case, Ann’s gain of $337,500 is over the $250,000 limit. Ann has $87,500 in excess of the $250,000 exclusion amount, which can potentially be subject to federal capital gains tax.
What do I need to know about taxes on life insurance when claiming as the beneficiary of my spouse’s policy?
Life insurance provides protection for surviving family members when the insured person dies. At death, the named beneficiary will file a claim and receive a check for the death benefit proceeds. There are two main categories of life insurance — term and permanent. Term insurance typically expires after a certain amount of time, usually between 10 and 30 years. After the term ends, the policy ends, and the death benefit disappears.
Permanent life insurance provides a death benefit (plus some accumulated cash in the policy) for your “whole life” if the premium payments and cash value meet certain requirements. While there are a few circumstances where a death benefit may be partially taxed, such as if there was a loan on the policy or the benefit is not paid out in a lump sum, in most cases, death benefits received from either a term life insurance policy or a permanent life insurance policy are not taxable.
Example:
Ryan’s wife, Samantha, passed away unexpectedly on December 5, 2022. Samantha was only 52 years young, and both Ryan and Samantha have term life insurance policies in force. Each policy pays out $1,000,000 in non-taxable death benefits if the insured person dies within the term.
In this case, Ryan filed a claim and received $1,000,000 tax-free from the life insurance company. Ryan plans to use the proceeds for funeral expenses, their children’s college fund, mortgage, and investments for his eventual retirement. The other accounts Ryan inherited from Samantha have their own rules and taxes depending on account type. For example, Ryan was listed as Samantha’s beneficiary for her IRA. Ryan plans to treat the IRA as his own, subject to normal required minimum distribution rules.
Losing a spouse can be devastating as you simultaneously grieve and adjust to a new normal. It is important to seek support from those around you. If you find yourself struggling with financial decisions, please do not hesitate to reach out to us at Greenspring — we are here to help.
