What are the personal income tax consequences of the death of a self-employed taxpayer?

The regulations do not clearly indicate how to proceed in the event of the death of a business taxpayer. However, it is incumbent on the heirs to settle all matters, not only tax matters, related to the business conducted by the testator. The tax consequences of the death of an entrepreneur largely depend on whether the heir intends to continue the business or liquidate the existing business.

Assumption of rights and obligations

The effect of a taxpayer's death in terms of tax law is that the taxpayer's heirs take over tax obligations and rights, as well as, in certain situations, non-property rights.
This is because, according to Article 97 of the Tax Ordinance, the heirs of a taxpayer take over the obligations and property rights of the testator as provided for in the tax law. In turn, the non-property rights of the testator, related to business activity, are transferred to the heirs on the condition that they continue to carry out this activity on their account. Also, the rights and obligations from the testator's function as a taxpayer pass to the heirs on the condition that they continue their activities.
Pursuant to the provisions of Article 98 § 1 of the Tax Ordinance, the provisions of the Civil Code on acceptance and rejection of the inheritance and liability for inherited debts apply to the liability of heirs for the tax obligations of the testator.
If the testator was personal income tax payer, the tax authority shall inform the heirs, on the basis of the data in its possession, of the amount of the testator's income or revenue and the amount of advance tax or tax paid, at the same time stating the amount of tax to be paid or the amount of overpayment. If the testator has incurred expenses entitling to tax benefits, the heir shall, within 30 days of receiving the above information, notify the tax authority of the amount of expenses incurred. After the expiration of this deadline, the tax authority serves the heirs with a decision determining the amount of the tax liability or stating an overpayment (Article 104 of the Tax Ordinance).

Filing of PIT-5, PIT-5L returns

Among the basic obligations of a businessman in settling accounts with the tax office when running a business is not only the payment of advance tax payments, but also the submission of monthly returns. The death of a taxpayer disrupts the regularity of settlements with the tax office.

Example
Francis Z., who ran a business, died on March 25, 2005. His business income was subject to 19% flat tax. The PIT-5L return - with advance payment settlement for March - should have been filed by April 20, 2005. In this situation, the question is whether Francis Z.'s heir should file such a declaration? However, the obligation to file the return is incumbent on the taxpayer, not on the heir, and is not inheritable.
As indicated above, the rules for determining personal income tax on the death of a taxpayer are regulated by Article 104 of the Tax Ordinance. It is the responsibility of the head of the tax office with jurisdiction over the last place of residence of the testator to calculate the income tax payable by the deceased taxpayer. It is therefore necessary to notify the head of this tax office of the death of the taxpayer. On the basis of the data in his possession, he informs the heirs of the amount of the testator's income or revenue and the amount of advance tax or tax paid, at the same time stating the amount payable or overpaid. He then issues a decision in which he determines the amount of the tax liability or declares an overpayment. Franciszek Z.'s heir should therefore wait for the decision of the head of the tax office.

According to opinions expressed by the tax authorities, however, in the case where the business activity of the testator is continued by the heir of the deceased taxpayer - the obligation to file returns will exist for the period when he carries out this activity in his own name and on his own account. The heir, however, already makes such settlements in his own name.

Filing an annual tax return

There is also no obligation to file an annual tax return for a deceased person. The obligation to file a tax return on the amount of income earned (loss incurred) in the tax year according to an established format is imposed on taxpayers by Article 45 paragraph 1 of the Law on p.d.o.f. The taxpayer is obliged to confirm with his own signature the data shown in the return. However, the obligation to file such a return (for a deceased taxpayer) is not inheritable. As indicated above, in a situation where the testator has not filed a tax return for a given tax year, the liability, if any, of the heirs will result from a separate decision, determining the amount of the tax liability. The tax should be paid within 14 days from the date of delivery of the decision determining the tax liability.

Responsibilities of the payer

Most problems arise when the deceased taxpayer employed workers. They are related to his obligations as a payer and, among other things, payment of advance income tax on wages.

Example
Sigmund F., who was self-employed, died on April 5, 2005. He employed workers. For March 2005, as a payer, he withheld advance payments of income tax on wages paid to employees, but did not pay them into the account of the tax office. In this situation, the question arises whether the son - who is the sole heir of Sigmund F. - has an obligation to pay these advance tax payments on wages paid to employees?
Upon the death of a self-employed individual, responsibility for tax liabilities (including collected but unpaid taxes due to the testator's function as a payer) is assumed by the heirs. However, the son of Sigmund F. cannot pay the tax advances collected but not paid by his deceased father to the account of the tax office before a decision is issued determining the amount of the heir's liability (cf. Article 100 § 1 and 2 of the Tax Ordinance - in accordance with the content of these provisions, the tax authorities competent for the last place of residence of the testator (in this case as a payer) rule in separate decisions on the scope of liability of individual heirs).
Accordingly, even if Sigmund F.'s son were to continue his father's business, under the above provision he should be deemed to wait for the decision of the head of the tax office. On the other hand, for the period of continuation of his father's business activities after his father's death, he should settle accounts with the tax office - also as a payer - already in his own name.

Obligation to prepare a liquidation inventory

The heir's duties also include preparing a liquidation inventory as of the date of the taxpayer's death. The basis for drawing up the inventory is § 27 of the Decree of the Minister of Finance dated August 26, 2003 on keeping a tax revenue and expense ledger (Journal of Laws No. 152, item 1475, as amended). According to its contents, taxpayers are required to prepare and enter in the book a physical inventory of trade goods, basic and auxiliary materials (raw materials), semi-finished goods, work in progress, finished goods, shortages and waste, as of January 1, at the end of each fiscal year, as of the date of commencement of business during the fiscal year, as well as in the event of a change of partners, a change in the proportion of partners' shares or liquidation of the business (in the event of liquidation of the business, the physical inventory must also include equipment).
This is because the preparation of a physical inventory is necessary to determine the income from the deceased taxpayer's business activities. Pursuant to Article 44 paragraph 4 of the Law on p.d.o.f., the tax is determined in the form of a lump sum of 10%. The amount of tax will be determined by the tax authority by way of a decision determining the amount of tax liability.
The prevailing view is that if the heir continues the business, the income from its liquidation should not be determined. For example, the position on tax settlements after the death of a person engaged in a business activity that was taxed with lump-sum income tax was taken by the Warsaw-Targówek Tax Office in a letter dated December 8, 2004, No. US37/ZDD/6A/DF/415/32/33/2004. According to its wording, if the heir continues the business after the deceased taxpayer and chooses the same form of taxation (i.e., lump-sum taxation), then he does not pay lump-sum income tax on the liquidation inventory after the deceased testator. When the goods are sold as part of a business activity, the income from that activity will be taxed at the appropriate flat rate.

Incorporation of the business after the deceased taxpayer into the business of the heir

The Tax Chamber in Gdansk, in a letter dated February 3, 2004, No. BI/005-0902/03, addressed the issue of incorporating the activities of a deceased taxpayer into an activity carried out independently by an heir. The letter concerned a taxpayer engaged in a sole proprietorship taxed on a general basis. The taxpayer intended to merge the business conducted in his own name with the business conducted by his deceased wife.
According to the Tax Chamber's position, the taxpayer could not combine the income, expenses and income earned from his self-employment business with the amounts resulting from the accounting devices maintained by his deceased spouse. This is because an income tax liability is a personal liability and is assigned to a specific individual.

Loss deduction

Among the important issues related to the death of the testator is the question of whether the heir, continuing the testator's business, is entitled to deduct from income the previous years' losses reported in tax returns in previous years by the testator for his business activity?
From an analysis of the wording of Article 97 § 1 of the Tax Ordinance, it appears that it applies only to the assumption by heirs of the property rights and obligations of the testator. However, it does not apply to rights of a personal nature of that person. Upon the death of a taxpayer who is an individual, his legal capacity ceases, and thus rights and obligations of a personal and non-transferable nature are extinguished. The prevailing view is that the right to deduct previous years' losses from income (Article 9(3) of the Law on p.d.o.f.), on the other hand, is a right of a personal nature, closely related to the person of the taxpayer, and is not subject to inheritance in light of the provisions of the Civil Code (Article 922 of the Civil Code) or takeover by heirs under Article 97 § 1 and 2 of the Tax Ordinance.
A loss reported in a return by a deceased person can therefore only affect the amount of his liability, which can pass to his heirs in succession. However, the rights of the deceased closely related to his person do not become the subject of tax succession. Thus, the heir cannot effectively exercise the rights of the deceased taxpayer and reduce his income by the amount of the loss incurred by the testator from his business activities.

Storage of books

In practice, there is the problem of what to do with tax books if the business is not continued after the taxpayer's death. Taxpayers obliged to keep books and other records shall keep them and the documents related to them until the statute of limitations on tax liability expires, according to Article 86 § 1 of the Tax Ordinance. A tax liability, according to Article 70 § 1 of the Ordinance, becomes time-barred at the expiration of 5 years, counting from the end of the calendar year in which the deadline for payment of the tax expired. Thus, the heir is obliged to keep records of the business activity conducted by the testator for the period indicated in the above provisions.

Legal basis: Act of July 26, 1991 on personal income tax (consolidated text, Journal of Laws No. 14, item 176, as amended), Decree of the Minister of Finance of August 26, 2003 on keeping a tax revenue and expense ledger (Journal of Laws No. 152, item 1475, as amended), Act of August 29, 1997. - Tax Ordinance (Journal of Laws of 2005, No. 8, item 60, as amended), Act of April 23, 1964. - Civil Code (Journal of Laws No. 16, item 93, as amended).