When an individual passes away, tax issues are one of the many things that must be considered. For most individuals who pass away, a final income tax return must be filed with the Internal Revenue Service (IRS) and state (if the particular state also taxes income) to settle any income tax liability that may exist. Much less commonly, a federal estate tax return and state estate tax returns (if the state has an estate tax or the decedent held property in a state that has an estate tax) may also be required. Federal estate tax returns are designed to ensure that the federal government can properly assess the amount of estate taxes (if any) due upon the death of a taxpayer. While these types of returns are rarely filed today, there are still a number of reasons why it may be beneficial to file such a return with the IRS, even if not necessarily required (though a state estate tax return may be needed in some states).
For Whom Must an Estate Tax Return Be Filed?
Not everyone must have a federal estate tax return filed for them. According to the IRS, for those who passed away in 2020, an estate tax return (IRS Form 706) must be filed if the size of the deceased’s gross estate, plus any taxable gifts made during the deceased’s life, exceeds $11.58 million (this amount increased to $11.7 million for those who die in 2021). When calculating the size of an estate, the following items should be included:
- all property in which the deceased had an interest
- transfers of property for which the deceased did not receive full compensation or value
- annuities
- the includible value of various types of jointly owned property
- certain life insurance proceeds (depending on the type of policy)
- community property
- various other types of property interests[1]
In addition to those who have estates over $11.58 million in 2020, an estate tax return must also be filed for a deceased individual if the surviving spouse wants or needs to preserve the deceased spouse's unused exclusion amount (DSUE). This is sometimes referred to as “portability” and allows a surviving spouse to preserve, for the surviving spouse’s own later use, the unused portion of the deceased spouse’s estate tax exemption. For example, if the deceased spouse’s share of the couple’s property was only $5 million, an additional $6.58 million could be preserved and allocated to the surviving spouse’s total estate tax exemption amount to use against the survivor’s future estate tax liability.
Portability can therefore be an incredibly valuable benefit to a surviving spouse who may have a large estate upon the surviving spouse’s own death that needs to be protected from future estate taxes. This is especially true if the current high estate tax exemption amounts are reduced in the future. The currently high exemption amount is scheduled to sunset at the end of 2025. At that time, the federal estate tax exemption may return to $5 million (adjusted for inflation), $3.5 million, or some other amount determined by Congress.
Who Must File and When?
The person responsible for filing an estate tax return is referred to in the IRS regulations as the executor. The term “executor” includes the executor, personal representative, or administrator of the deceased’s estate. These are roles to which someone is typically appointed in a state probate court proceeding. However, if for some reason an executor for the estate is not appointed by a local court, the IRS considers anyone who is “in actual or constructive possession of any property of the decedent” to be an executor and requires that individual to file the estate tax return if filing one becomes necessary. This is often the case when all of the deceased’s property is held in a trust and no probate is required to administer the estate and trust of the deceased person. In that case, the then-acting trustee of the trust would be considered the executor for estate tax return purposes.
Any estate tax return must be filed within nine months of the date of death. If that does not provide enough time, you can request an extension from the IRS by timely filing Form 4768, which will typically provide you with an automatic six-month extension of time to file. If you are filing a Form 706 purely for portability reasons, there are some exceptions to these filing requirements that should be reviewed if you fail to file within the initial nine-month period after the date of death.[2]
Just because you are the executor for the deceased’s estate does not mean that you have to do all of this alone. In fact, most individuals will want to hire a professional tax preparer who has experience with preparing estate tax returns. Such tax preparation professionals will have the skills, experience, and tools to help this process go much more smoothly. Furthermore, allowing a tax professional to assist you will help ensure that you do not miss any important details before filing and provide important liability protection for you as the executor for possible mistakes made on the return.
How to Help Prepare for the Estate Tax Return Filing
The first thing you can do to assist in the estate tax return preparation process is to gather a complete inventory of the property of the deceased individual. Bank and account statements, property records, life insurance policy statements, business appraisals, and similar records will be crucial for the tax preparer to review. Past income tax returns can also help the tax preparer identify other sources of income-generating property that may have a value for estate tax return preparation.
Once you have gathered this information for your tax preparer, authorize the IRS to be able to share with and obtain tax information from your tax preparer. This is done through IRS Form 8821, Tax Information Authorization. If you also wish to have the tax preparer represent you and the estate before the IRS, you should instead file IRS Form 2848. Without this authorization, your tax preparer’s ability to assist you with the preparation and filling of the estate tax return will be severely limited. In addition, as the executor of the deceased’s estate, you will need to file IRS Form 56, Notice of Fiduciary Relationship, so that the IRS will know that you are the contact person and the one ultimately responsible for answering any questions that arise during the tax preparation and filing process.
Valuing Specific Items of Property
Properly valuing certain items of property such as real estate, business interests, collections of art or other collectibles like firearms, coins, jewelry, and other high-value items will not only be required for establishing the value of the gross estate for estate tax purposes, but will also be important to the individuals who will ultimately inherit the property. Under current law, most appreciated property owned by a deceased individual will receive a step-up in tax basis as a result of the death of the owner. In general the inherited property receives a new tax basis of the date-of-death value of the property.[3] This is important to document so that when the property is later sold, the amount of capital gains taxes due on the sale of that property can be minimized. Without adequate documentation of the date-of-death value, the IRS may claim more capital gains taxes are due on the sale of that property than would otherwise be justified.
Once you have determined the value of the property through the use of professional appraisals or by other reliable methods, document how the valuations were calculated and provide that documentation (for example, appraisal reports) to the tax preparer to attach to the estate tax return.[4] Be aware that when it comes to valuations of unique property such as art, certain real estate, and business interests, using professional appraisers may be more expensive on the front end. However, using professional appraisers can also result in greatly decreased risk of being challenged by the IRS, which may ultimately save you far more time and expense than you would have saved by not using a professional appraiser.
How Long Does This Process Take?
As mentioned, the IRS gives you nine months from the date of death to file an estate tax return for the deceased. If that is not enough time, then you can request an additional six-month extension that is automatically granted if the request is filed with the IRS before the nine-month estate tax return due date. If you need more time, you can request additional time for “good cause shown” if you can convincingly explain to the IRS why it would be unreasonable or impractical to file the return prior to the fifteen months otherwise available through the automatic extension period.[5] However, you need to give the IRS sufficient time to consider your reasons for requesting additional extension and that should be done well before the initial nine-month deadline for filing the return.[6] Regardless of when the tax return is ultimately due, the tax payment (even if only estimated) is due nine months after the date of death. Failure to pay the tax due by that date will cause the estate to incur penalties and interest. Nevertheless, there are separate procedures for requesting an extension of time to pay the taxes due if the estate does not have the cash available to pay the tax.[7] Just be aware that requests for extending tax filing deadlines and for extending payment deadlines are independent of each other. You must request both if you need both.
Conclusion
For now, federal estate tax returns are still fairly rare because of the historically high estate tax exemption amounts available to taxpayers. However, it may still be advisable for a surviving spouse to file an estate tax return to preserve the DSUE, even if the value of the estate is well under the exemption amount, to account for changes in the law and future appreciation in the estate. Additionally, the Biden administration is taking a close look at reducing the currently available estate tax exemption amount in an effort to fund many existing and future government programs. As a result, federal estate tax returns may become much more common in the near future than they have been over the last several years. Nevertheless, with a little professional help and some willingness on your part to roll up your sleeves and gather the necessary information for the tax return, there is little to fear. You’ve got this!
[1] Dep’t of the Treas., I.R.S., Instructions for Form 706, at 2 (rev. Sept. 2020), https://www.irs.gov/pub/irs-pdf/i706.pdf.
[2] Id.
[3] I.R.C. § 1016.
[4] Dep’t of the Treas., I.R.S., supra note 1, at 20.
[5] I.R.C. § 20.6081-1.
[6] Id. § 20.6081-1(c) (“Form 4768 should be filed sufficiently early to permit the Internal Revenue Service time to consider the matter and reply before what otherwise would be the due date of the return.”).
[7] Id. § 20.6081-1(e).