Unfortunately, the Internal Revenue Service isn't about to give you a tax break and allow you to take a deduction for the cost if you pay for a loved one's funeral. Your own death is a different matter, however. Although funeral expenses are non-deductible for living individual taxpayers, estates can claim these costs when the executor is preparing final tax returns. As with all tax rules, however, this one is subject to some limitations.
If your estate is large enough to be vulnerable to the federal estate tax, deducting the costs of your funeral can help prevent this taxation. Estate taxes are levied on the overall value of the assets you leave behind when you die, less deductions for your debts and certain allowable expenses. Your funeral is an allowable expense, and the executor of your estate can subtract the cost on Schedule J, which is attached to IRS Form 706, the estate tax return. Most estates don't have to file Form 706, however, because they're not liable for estate taxes. As of 2013, the federal government only taxes estates valued at more than $5.25 million after allowable deductions, and then only on the portion of the estate that exceeds this amount.
Estate Income Tax
Even if your estate squeezes in under the $5.25 million mark and doesn't have to file Form 706 or pay an estate tax, the funeral expense deduction may not be lost. Assuming you leave any assets that generate income, such as interest, the portion earned after the date of your death may be taxable to your estate if the asset doesn't pass directly to a named beneficiary. If such income exceeds $600 for the year, your estate must pay income tax as well, and this is separate from Form 706, the estate tax return. Estate income is reported on Form 1041, and this form allows your executor to claim your funeral expenses as a deduction as well.
The IRS limits funeral deductions to expenses that are reasonable and necessary. For example, putting your Aunt Ida up at the best hotel in town for a week so she can attend is not a funeral expense – your funeral would go on as planned even if she had to stay with another relative. Spending $60,000 on an above-ground crypt might be perfectly acceptable, however, and the IRS might even allow your executor to deduct the cost of a buffet later at the hotel your aunt isn't staying at. It depends on whether you've specifically requested these funeral arrangements in your will or trust documents, and whether it's logical that someone in your income bracket would go to such an expense.
Taking the funeral expense deduction depends on your executor paying for your burial from estate funds. If someone else does it, the deduction is lost. For example, if your estate receives death benefits from Veterans Affairs and uses this money to fund your funeral, the cost isn't deductible unless it exceeds the received benefits, and then your executor can only write off those expenses incurred over and above the amount of the benefits. The same applies if a relative pays for your funeral.