Navigating the Form 706Navigating the Form 706

For estate-planning professionals, one of the more complex aspects of administering a client’s estate is the preparation of Internal Revenue Service Form 706, the United States Estate (and Generation-Skipping Transfer) Tax Return. While a seemingly straightforward task of reporting a decedent’s assets and calculating the tax, Form 706 presents numerous traps for the unwary. Errors can lead not only to significant tax consequences for the estate but also to professional liability for the practitioner. 

Let’s explore some common mistakes and elections on estate tax returns. Given the substantial tax implications, practitioners should approach the preparation carefully and thoroughly understand the decedent’s estate and relevant tax laws. As Benjamin Franklin once said, “An ounce of prevention is worth a pound of cure,”¹ and this rings especially true when preparing an estate tax return. 

Timeliness

First and foremost, estate-planning professionals must determine whether an estate is required to file Form 706 and ensure timely filing. Generally, the return is required if the decedent’s gross estate, plus lifetime taxable gifts, exceeds the estate tax exemption threshold. Estates of decedents dying in 2024 must file a federal estate tax return if the gross estate, plus gifts, exceeds $13.61 million.² This threshold increases to $13.99 million for decedents dying in 2025. 

In most cases, Form 706 must be filed within nine months of the decedent’s death. Missing this deadline can lead to penalties and interest or the loss of the opportunity to take advantage of certain elections. Although there’s a 6-month extension available (by filing Form 4768), the estate tax liability must still be paid by the non-extended deadline to avoid interest and penalties.

Even if the estate is below the filing thresholds, it may still need to file to use certain elections, such as the portability election or generation-skipping transfer (GST) tax allocations (discussed below). These elections are crucial for effective tax planning and can influence how assets are distributed and taxed. Additionally, even when a federal return isn’t required, an estate may still be obligated to file a state estate tax return, as many states have their own estate tax filing requirements with lower exemption amounts. 

Portability Elections

One of the most valuable planning tools available to married couples is the estate tax portability provision, which allows a surviving spouse (for decedents dying after 2010) to inherit the deceased spouse’s unused estate tax exemption, effectively increasing the estate and gift tax exemption available to the survivor.³ This election, however, isn’t automatic; an estate must take action to claim portability.  

To take advantage of the portability provisions, Form 706 must be timely filed for the decedent’s estate, even if the estate is below the applicable estate tax exemption amount. As previously discussed, the due date is generally nine months from the decedent’s death (or 15 months if extended).

Estates that fail to meet the 9-month filing deadline but still wish to elect portability can take advantage of a special rule that permits filing an estate tax return within five years of the decedent’s death. Revenue Procedure 2022-32 offers a valuable “second chance” for estates to elect portability, providing a crucial lifeline when an estate misses the initial deadline. It’s important to note that only estates that weren’t otherwise required to file Form 706 are eligible for this extended deadline. This 5-year window is a key safety net, offering flexibility for smaller estates or when the need to file wasn’t clear at the time of death.⁴ 

Given the importance of portability for certain taxpayers, practitioners must be diligent in advising clients on the process and the availability of portability. This includes confirming the advisability of filing and ensuring that all deadlines are met. Estate planners should proactively include this election in their planning to avoid any loss of exemption. 

Alternate Valuation

The alternate valuation election allows an estate to choose a valuation date six months after the decedent’s death rather than using the date-of-death values^.5 An estate can only take advantage of this election if it results in a lower gross estate value and a decrease in the combined estate and GST tax. An alternate valuation election must be made on the estate tax return and only on a late-filed estate tax return if the return isn’t filed more than one year from the due date (including extensions).⁶

When property is inherited from a decedent, it typically receives a stepped-up basis equal to the value used on the estate tax return. Therefore, the decision to use alternate valuation can affect the beneficiary’s basis. Accordingly, while using alternate valuation can reduce estate taxes, it can also increase income taxes if the property is later sold. Ultimately, while the alternate valuation election can be a powerful tool for reducing estate taxes, practitioners should evaluate this tool carefully to ensure it aligns with the estate’s goals and keep in mind potential challenges from beneficiaries. 

Marital Deduction

A decedent can generally leave an unlimited amount of property to a surviving spouse using the estate tax marital deduction.⁷ However, interests subject to termination don’t automatically qualify for the marital deduction.⁸ These “terminable interests” include property passing to a trust for a spouse’s lifetime. 

The qualified terminable interest property (QTIP) rules provide an important exception to this rule. A QTIP allows a decedent to control the distribution of their estate while still ensuring the surviving spouse receives income for life. To use this QTIP rule and take a marital deduction, a proper QTIP election must be made on Form 706, using Schedule M. Failure to follow the QTIP election rules could result in the loss of a tax savings marital deduction. 

The preparer must also understand the rules that apply when the surviving spouse isn’t a U.S. citizen. To qualify for the marital deduction in such a case, the property must be placed in a qualified domestic trust (QDOT).⁹ This election is also made on Form 706 and helps manage estate tax exposure.

Managing the GST Tax Exemption

When Congress enacted the estate tax, it anticipated that wealth would be taxed each time it passed down a generation. Taxpayers soon realized, however, that they could easily avoid a level of tax by transferring property directly to the grandchildren. To counter this, Congress introduced the GST tax. This tax adds a second level of tax to transfers to individuals two or more generations younger than the transferor.¹⁰ Essentially, the GST tax applies to these transfers as if the wealth were first transferred to the children and then to the grandchildren. This tax can quietly erode wealth passed down through generations.

When an estate includes GSTs, Form 706 must account for any GST tax liability, and the GST tax exemption should be allocated accordingly. Form 706 allows for allocating the GST tax exemption to specific transfers, requiring estate planners to review both the decedent’s estate-planning documents and prior gifts to ensure the correct exemption is reported and used. Unlike the estate tax exemption, the GST tax exemption isn’t portable to a surviving spouse, and any unused portion is forfeited. Therefore, maximizing the available GST tax exemption on the estate tax return is an important step in preparing Form 706.

The ability to make a reverse QTIP election also shouldn’t be overlooked. For GST purposes, this election allows the taxpayer to treat the transfer to the QTIP trust as if no QTIP election had been made, thereby enabling the allocation of GST tax exemption to the trust.¹¹ For GST purposes, the decedent is treated as the transferor of a reverse QTIP trust. The election, which is made on Schedule R of Form 706, is particularly useful when a decedent has more GST tax exemption available than estate tax exemption and can be a beneficial tool to fully use the GST tax exemption. 

Choosing the Deduction

Estates frequently incur expenses that may be deductible on both the estate tax return and the fiduciary income tax return (Form 1041). However, there are restrictions on claiming these deductions on both forms simultaneously. The return preparer should evaluate which deduction option offers the best tax advantage. 

Given the minimal difference between the 40% estate tax rate and the 37% maximum federal income tax rate, deciding where to deduct administration expenses can be nuanced. Carefully consider factors such as whether there’s sufficient income to benefit from an income tax deduction and the impact of state taxes.

The choice between deducting administration expenses on Form 706 or Form 1041 is further influenced when the estate claims a marital deduction on Form 706. The marital deduction applies only to the net value of property passing to the surviving spouse (or a marital deduction trust). Any encumbrances or obligations imposed on the surviving spouse related to this property must be factored into the marital deduction calculation.¹² Administration expenses fall into two categories: estate transmission expenses, which can reduce the marital deduction if charged against marital property, and estate management expenses, which typically don’t reduce the marital deduction if deducted on the estate’s income tax return.¹³ Therefore, it’s essential to carefully consider the categorization of administration expenses and the specific impact on the marital deduction, which is essential in determining where to claim administrative expense deductions.

Basis Consistency Compliance

After filing Form 706, assess whether Form 8971 is also required. Due to its relatively recent introduction, this requirement is often overlooked. Form 8971 reports the values of assets inherited by beneficiaries, ensuring the correct basis is communicated to both the IRS and beneficiaries for income tax purposes. 

Form 8971 must be submitted within 30 days of the Form 706 due date or filing date, whichever is earlier. Executors should ensure both forms are submitted accurately and on time to safeguard the correct basis for inherited property and minimize the risk of income tax reporting errors.

Omitting Assets

It isn’t uncommon for assets to be incorrectly omitted from an estate tax return, particularly regarding life insurance, foreign assets or jointly held property. This can result in an incomplete estate tax return and potential penalties for underreporting the estate’s value.

It’s important to recognize that life insurance proceeds on a decedent’s life must be disclosed on Form 706, even if the decedent wasn’t the policy owner (for example, when a trust or a business owns the policy). Whether the proceeds will be included in the taxable estate or disclosed with a zero-inclusion value depends on whether the decedent held any incidents of ownership over the policy. 

Foreign assets, including bank accounts and property, must also be reported and are often missed. It’s important to inquire about all worldwide assets.

Joint interest property can be missed or underreported due to misunderstandings about ownership types, misapplication of survivorship rules or failure to properly value the decedent’s share. For non-spousal joint interests, the practitioner should establish whether contributions were unequal to determine what portion of the jointly owned property is included in the estate.¹⁴ 

Fitting the Pieces Together

Preparing Form 706 is like assembling a puzzle—each piece plays a crucial role in completing the picture. A misstep in placing the pieces, like missing a deadline or election, can disrupt the entire plan, leading to costly consequences. By proactively identifying potential pitfalls and using available elections, practitioners can not only minimize tax liabilities but also safeguard the estate’s goals and protect the interests of beneficiaries. 

Endnotes

1. https://learningenglish.voanews.com/a/an-ounce-of-prevention-is-worth-a-pound-of-cure-/5326585.html.

2. Internal Revenue Code Section 2010(c) as indexed for inflation.

3. See IRC Section 2010(c)(4).

4. Estates that miss this 5-year deadline can request relief from the Internal Revenue Service via the private letter ruling process. See Revenue Procedure 2024-1. The estate must be below the Form 706 filing threshold to be eligible for such relief.

5. IRC Section 2032. In the case of property distributed, sold, exchanged or otherwise disposed of, within six months after the decedent’s death, such property is instead valued as of the date of distribution, sale, exchange or other disposition.

6. Section 2032(d)(2). Relief to make the election may also be available under Treasury Regulations Sections 301.9100-1 and 3.

7. IRC Section 2056.

8. Section 2056(b).

9. See IRC Section 2056(d)(2) and Section 2056A.

10. See 26 U.S. Code Chapter 13.

11. IRC Section 2652(a)(3).

12. Section 2056(b)(4).

13. See Treas. Regs. Section 20.2056(b)-4(d). These rules also apply to a charitable deduction. See Treas. Regs. Section 20.2055-3.

14. See Treas. Regs. Section 20.2040-1(a)(2).