It’s a constant, death and taxes. And even death doesn’t stop the tax man. As part of wrapping up your estate, your executor must file a final income tax return with the IRS. This tax return is for the portion of the last year you were alive.
For Whom Must an Estate Tax Return Be Filed?
The type of tax returns which must be filed will depend on two factors, 1) the state where you reside and 2) the amount of assets you have at the time of your death.
The State of Texas foregoes inheritance tax, much like federal income tax. Meaning, your estate will not be subject to state taxes, only federal ones, if you have what is known as a “taxable estate.” In order to have a taxable estate, you must have assets in excess of the federal lifetime tax exemption. In 2021, this means your assets must exceed $11.58 million dollars (individually) or $23.16 million (for married couples). When calculating the size of an estate, the following items should be included:
- all property in which you have an interest (real estate, mineral interests, stock distributions, etc.)
- transfers of property for which you did not receive full compensation or value
- annuities
- be sure to include your portion of the 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]
Portability
In addition to those who have estates over $11.58 million in 2021, 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.”
Portability allows your surviving spouse to preserve (for their later use) the unused portion of the your estate tax exemption. An example would be, if the your share of the marital property was only $5 million. This amount is well below the lifetime exemption and you would be able to pass this money on to your loved ones without incurring estate tax. Then, the additional $6.58 million of your lifetime tax exemption could be preserved and transferred to your spouse’s total estate tax exemption to use against their future estate tax liability. What this means is, your spouse could then pass on $18.16 million dollars to your descendants, without incurring estate tax liability. As you can see, portability can therefore be an incredibly valuable benefit to a surviving spouse who may have a large estate that needs to be protected from future estate taxes.
While most of us don’t have enough assets to qualify for a taxable estate, be aware that the lifetime exemption amount is subject to change. It has been raised and lowered over the course of several decades (as covered by this blog), and will be changing again in 2025 (to a projected $5 million in individual assets), though the final number is not yet clear. Meaning that while you may not have a taxable estate right now, you may have one in the future, when the lifetime exemption changes.
Who Must File?
The person responsible for filing an estate tax return is referred to in the IRS regulations as the executor. The term “executor” by IRS meaning is something of a catch-all term, and includes such roles as the executor, personal representative, or administrator of the deceased’s estate. Usually the probate court will appoint someone to one of these roles.
However, if for some reason the probate court doesn’t appoint an executor, the IRS considers anyone who is “in actual or constructive possession of any property of the decedent” to be an executor. The IRS will require that individual to file the estate tax return if necessary. This is often happens when all of the deceased’s property is held in a trust and no probate is required to administer the estate. In that case, the trustee would be considered the executor for estate tax return purposes.
When Must a Tax Return Be Filed?
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 typically provides you with an automatic six-month filing extension. Be aware, 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 want the tax preparer to represent the estate before the IRS, you should file IRS Form 2848. Without this authorization, your tax preparer will be limited in their ability to assist you with the preparation and filling. In addition, as the executor of the deceased’s estate, you will need to file IRS Form 56 (Notice of Fiduciary Relationship). The forms tells the IRS that you are the contact person. You will be responsible for answering questions that arise during the tax preparation and filing process.
Determining the Value 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 for tax purposes, but is also important for 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. For a more complete explanation of the step-up in basis, please see our earlier blog post on the topic.
Steps After Completing the Valuations
Once you have determined the value of the property, 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, going to a professional can greatly decrease the risk of being challenged by the IRS. This may ultimately save you far more time and expense than you would have by not using a professional appraiser.
How Long Does This Process Take?
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. This extension is automatically granted if the request is filed with the IRS before the due date. If you need even more, you can request additional time for “good cause shown.” However, you will need to explain to the IRS why it is unreasonable to file the return prior to the fifteen months otherwise available.[5] Keep in mind, you need to give the IRS sufficient time to consider your reasons for requesting additional extension, so this request should be made well before the initial nine-month deadline for filing the return.[6]
Regardless of when the tax return is due, the tax payment is due nine months after the date of death. Failure to pay by that date will cause the estate to incur penalties and interest. Nevertheless, there are separate procedures for requesting an extension to pay the taxes. Extensions are permitted if the estate does not have the cash available to pay.[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
Federal estate tax returns are still fairly rare because of the historically high estate tax exemption amounts available to taxpayers. However, a surviving spouse should consider filing an estate tax return to preserve the DSUE. They should do so even if the value of the estate is well under the exemption amount, to account for changes in the law and future appreciation of the estate.
Despite all the confusion surrounding deadlines and forms and appraisals, with professional help and effort to gather the necessary information, there is little to fear. You’ve got this!
Give Us a Call
Nielsen Law PLLC provides family focused estate planning to individuals and families in Austin, Round Rock, Cedar Park, and the Central Texas area. For more information and to learn about our firm, please contact us.
[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).
