When Congress averted the fiscal cliff plunge in January 2013, it preserved the $5 million estate tax exemption and added provisions to adjust it periodically for inflation. As a result, the executors of most estates aren't required to file Internal Revenue Service Form 706, the estate tax return. There may be a few good reasons to do so anyway, however.
Estate taxes are due on the total value of a decedent's assets, less marital deductions, debts and costs of operating the estate. The exemption for 2013 is $5.25 million, so your executor would only have to file Form 706 and pay estate taxes on any resulting value that exceeds this amount after taking the exemption. For example, if your estate is worth $5.5 million after all calculations, your executor would have to pay an estate tax on $250,000. If you left your entire estate to your spouse, however, no estate tax is due – this is the so-called marital deduction and it's protected from estate tax. Your executor has nine months from the date of your death to file Form 706, but she can request an extension.
As of 2013, you and your spouse can give away $28,000 each year to as many gift recipients as you choose, without incurring a gift tax. If you're not married, you can give away $14,000 annually to each recipient. Gifts made over this annual exclusion must be accounted for as part of your estate when you die. This can increase its value and result in your executor having to file Form 706 and pay taxes. You're supposed to report your gifts to the IRS every year so it can be sure your estate is reporting the difference correctly when it's time to file Form 706. The estate tax exemption applies to both estate taxes and gift taxes, so after your gifts are added to the value of your estate, the same $5.25 million exclusion can be deducted.
Generation-Skipping Transfer Tax
The generation-skipping transfer tax is also reported on Form 706, so if you made sizable gifts to your grandchildren or to anyone else two generations removed from you, your executor may have to file this return. The 2013 exemption for the generation-skipping tax is also $5.25 million.
Even if your estate doesn't owe any estate tax, generation-skipping tax, or gift tax, your executor might want to file Form 706 anyway if you’re married. The fiscal cliff deal also preserved the concept of portability, which means that you can give any unused portion of your estate tax exemption to your spouse so her estate can use it when she dies. For example, if your estate is worth $4 million, you'd use the exemption to shield that amount from taxation and there would be $1.25 million left over. Portability allows you to give this $1.25 million exemption to your spouse so her estate would have a $6.5 million exemption at the time of her death. The only way that her estate can claim portability, however, is if your executor files Form 706 even if you don't owe any taxes.
Another reason to file Form 706 even if your estate doesn't owe taxes is to establish the tax basis for gifts made to beneficiaries. For example, if you leave someone your home and she doesn’t want to live there, she might decide to sell it instead. She would then have to pay capital gains tax on any difference between the home's value – its basis – and the sales price. The basis for inheritances is "stepped up" to the date of your death – it's not what you originally paid for the property. If your executor files Form 706, it establishes the date-of-death value with the IRS, so your beneficiary could potentially avoid any capital gains tax if she sells relatively soon after receiving the inheritance, before the property appreciates in value.
- IRS: Instructions for Form 706
- Frantz, McConnell & Seymour: Passage of the "American Taxpayer Relief Act" or "the Fiscal Cliff Compromise" Makes Significant Changes to Federal Gift and Estate Taxes
- American Institute of CPAs: Form 706 and Instructions Provide Guidance on Portability Election
- Forbes: After the Fiscal Cliff Deal – Estate and Gift Tax Explained
- Bosch Appraisal & Estate Services
- Tax Policy Center: Wealth Transfer Taxes – How Do Estate, Gift, and Generation-Skipping Transfer Taxes Work?
- Mondaq: 2013 Brings Brings Estate, Gift and GST Tax "Permanency" at Last
Beverly Bird has been writing professionally for over 30 years. She is also a paralegal, specializing in areas of personal finance, bankruptcy and estate law. She writes as the tax expert for The Balance.