Estate PlanninG

Filing Estate Tax Returns Does Not Have to Be Intimidating

Taxes are one of those realities that executors and heirs need to deal with after the death of a loved one. For most, a final federal and state income tax return must be filed if the individual earned any income during the year of their death. And although it is far less common and typically impacts only very wealthy individuals, an estate tax return may need to be filed as well. Filing estate tax returns may seem intimidating, but it is not quite as menacing with the right guidance and professional assistance.

What Are Estate Taxes?

Estate taxes are those taxes levied against a deceased party’s estate. They are paid by the estate, not by the heirs, but this must be done before assets can be distributed. California has no estate taxes, and federal estate taxes are only required in the case of very wealthy individuals. However, there are times an individual will want to file an estate tax return, even if it is not required.

Who Files Estate Taxes On Behalf of the Deceased Party?

When someone dies, all taxes must be filed in order to settle any tax liabilities. The person responsible for filing any tax forms on behalf of the deceased is the personal representative, or executor of the estate. This is someone who was personally appointed by the deceased in their will or someone who was appointed by the court.

If, for some reason, no one has been appointed as executor, the IRS will consider any “person in actual or constructive possession of any property of the decedent” to act as executor to file taxes, if necessary. This can become necessary if the deceased’s assets are held in a trust where no probate was required. In this case, however, the trustee will typically be the one responsible for filing taxes.

Filing Estate Taxes

In California, we have no state estate taxes, but the deceased party may have owned property and assets in a state where there are estate taxes. Under current law, federal estate taxes will be owed only when the estate is substantial and falls above the exemption threshold. Federal estate taxes, as of 2021, are only levied on estates in excess of $11.7 million for an individual and double that for a couple. Anything over that threshold is subject to federal estate tax and estate tax filing.

In other words, if an estate is valued at $14 million, there will only be estate taxes due on the difference between that figure and the exemption threshold, or $2.3 million. The first million is taxed at between 18 and 39 percent, with anything above that being taxed at 40 percent.

What Must Be Considered as Part of the Estate When Calculating its Value?

Assets that must be considered when calculating the value of the estate for federal estate tax purposes must include:

  • Any properties that the deceased party had any interest in

  • Any transfers of property where the deceased had not received total compensation or value

  • Annuities

  • The value of any jointly-held property

  • Life insurance proceeds

  • Any community property

  • Any other various property ownership or interests

Deceased Spousal Unused Exclusion for the Surviving Spouse

Even if the estate does not exceed the exemption limit of $11.7, an estate tax return should still be filed if the surviving spouse wants to preserve their deceased spouse’s unused portion, or Deceased Spousal Unused Exclusion (DSUE). This is also known as portability. Portability allows the surviving spouse to use that unused portion at a later time for themselves. This can be valuable for a surviving spouse, since portability is permanent, but the current exemption threshold is scheduled to end in 2025 and may end up being far less.

When Must Estate Tax Returns Be Filed By?

Estate tax returns must be filed within nine months of the deceased individual’s death, although an extension can be requested from Internal Revenue. Form 4768 will provide for an extension of six months for filing. If a surviving spouse is filing for portability, there are some exceptions to these timelines that must be considered.

Preparing for Filing Estate Taxes

The executor must inventory all assets and properties of the deceased party as well as any financial holdings. These will include any bank account information, real property records, life insurance policies, business appraisals, past income tax returns, or any other documents that may enable the accountant or tax preparer to determine the value of the estate.

You can share and obtain information with Internal Revenue and your tax preparer. This is done with Form 8821 authorizing information sharing between parties and Form 2848 allowing the preparer to represent your interests. As executor of the estate, you will also be required to file Form 56, Notice of Fiduciary Relationship. This alerts Internal Revenue that you are the personal representative of the estate and the estate’s contact person in all tax matters.

Valuing the Property in the Estate

Valuing the estate is important for estate tax purposes as well as for the people who are inheriting the estate’s assets.

For those who inherit, they will receive a step-up in tax basis for the assets they receive. This means that there is an adjustment to the value of the property based on their value at the time it is passed on to them instead of the value of the property when it was first acquired. In this way, a beneficiary’s capital gains exposure is minimized. When the property is later sold, the capital gains are based on the date-of-death value.

Using the Right Professionals

Assets should be valued by professionals such as appraisers or other reliable professionals, with valuation calculations fully documented. This becomes part of the estate tax return. Although professional appraisers can be expensive, they offer much more protection if values are challenged by the IRS. Having a qualified professional appraisal can save time and expense in the long run and ensure that assets are correctly valued.

How Long Does the Estate Valuation Process Take?

Getting comprehensive valuations on all the assets in the estate can be time-consuming. Although you have nine months from the date of death, it may not be enough time to compile assets and get the appraised valuations. Although you do have the availability of Form 4768 for a six-month extension, it frequently still is not enough time.

If you still require more time, Internal Revenue will consider an additional extension if you can prove that you will be unable to file within the extended fifteen months. In order to do this, however, you must allow time for them to consider the request and make a decision within the time frame you have.

Despite the due date for the estate tax return, an estimated estate tax payment must be made within the nine month deadline of filing. Penalties and interest will be added to the amount due if this is not done. If there is not enough cash available to pay the estimated tax before the nine-month due date, there are procedures to extend the payment deadline. This must be done independently of the extension for filing request.

Getting the Assistance of a California Estate Planning Attorney

Although it is unlikely that most individuals will have to worry about filing for estate taxes, it is still advisable for surviving spouses to take advantage of their portability with a DSUE and file an estate tax return. But it may also be important to consider these matters when you are planning your own estate in the event that the exemption threshold goes back down to its pre-2017 Tax Cuts and Jobs Act increase.

The new administration may be looking at reducing the threshold for federal estate taxes when the current one expires. If so, estate taxes may once again become a factor for more of us.

Tax and estate laws are complicated and always in a state of modification. If you have questions as they concern you as an executor, a surviving spouse, or planning for your own estate, you should get the skilled legal guidance of a California estate planning lawyer to give you recommendations for your own unique situation and goals.

We’re available to help. To schedule a consultation, call Santaella Legal Group, serving San Ramon, Danville, Dublin, Pleasanton, the Tri-Valley and Bay Area at (925) 831-4840.