Category: IRS

Filing an Estate Tax Return

February 11, 2025
Estate Planning, Taxes

What is an estate tax return?

When you die, you will leave behind all your property (everything you own) and debts (everything you owe). All this is called your estate. After the debts have been paid, the various items left in your estate will be transferred to your heirs and beneficiaries, but first the federal government will take its share through estate taxes (gift and estate tax and generation-skipping transfer tax). The personal representative of your estate must file an estate tax return with the IRS if the value of your gross estate at death together with the value of all taxable gifts you made during life is more than a certain amount ($13,990,000 plus any deceased spousal unused exclusion amount in 2025). The federal estate tax return (Form 706) lets the IRS know how the estate taxes are calculated and how much tax is owed. Generally, the estate tax return must be filed within nine months after your death, but an automatic six-month extension is available if Form 4768 is filed on or before the due date for filing Form 706. An additional six months may be granted for good cause shown. The late filing penalty is 5% of the taxes due per month, up to 25%. This is in addition to any late payment penalty.

An estate tax return may also need to be filed with your state. This discussion focuses on the federal return only. Contact your state for information regarding its state death taxes.

Caution: The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act introduced a new portability feature, which allows a surviving spouse to take advantage of the unused applicable exclusion amount of a predeceased spouse who died after December 31, 2010. Normally an estate valued at less than the available exclusion amount would not be required to file an estate tax return; however, a return will now be necessary for nontaxable estates in order to record the amount of a decedent’s unused exclusion amount for a surviving spouse who may want to use it later.

If you are the owner of a closely held business, your personal representative may be able to defer payment of estate taxes owed on that interest for up to 15 years.

How do you calculate estate tax liability?

Calculating estate taxes is similar to calculating income taxes. It is basically a four-step process:

Determine what is taxable
Determine what isn’t taxable
Calculate the tentative estate tax
Subtract allowable credits from the tentative tax

The calculation looks something like this:

	Gross Estate (reduced by qualified conservation easement exclusion)
–	Funeral and administration expenses, claims and losses, charitable transfers, marital transfers, and state death taxes
=	Taxable estate
+	Adjusted taxable gifts
=	Cumulative taxable transfers
	Tax on cumulative taxable transfers
–	Gift tax payable on adjusted taxable gifts (as reduced by unified credit)
=	Tentative tax
–	The unified credit (or applicable credit amount), pre-1977 gift tax credit, foreign death tax credit, and credit for tax on prior transfers
=	Final estate taxes payable

How do you file an estate tax return?

The following explains how to fill out Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return and the various attachments.

This discussion here is for information purposes only. Do not attempt to complete an estate tax return based solely on the information provided here. Please consult Form 706 and the instructions to Form 706 for further information. You may also wish to consult an attorney or tax professional before filing an estate tax return.

Part 1 — Decedent and Executor

This section is looking for identifying information about the decedent, including name, Social Security number, domicile at time of death, year domicile was established, date of birth, and date of death. The executor’s or administrator’s name, address, and Social Security number must also be supplied. Additional questions ask whether the decedent left a will, the name and location of the court where the will was probated or the estate was administered, and the case number.

Part 2 — Tax Computation

This section is completed last as it contains information from other sections of the return and the applicable Schedules. After adding adjusted taxable gifts and subtracting allowable deductions from the gross estate, you will calculate a tentative tax (or gross estate tax). The estate taxes will then be reduced by available credits. When all the calculations are complete, the number on the bottom line of this section is what the estate owes the IRS.

Part 3 — Elections by the Executor

Generally, the value of your gross estate is the fair market value of all property on the date of your death. However, if your estate qualifies, your personal representative may elect the alternate valuation date that allows the gross estate to be valued six months after the date of death or on the date an asset is disposed of, whichever is earlier. The purpose of the alternate valuation date is to permit a reduction of the tax liability if the value of the estate’s property has decreased since the date of death. Special use valuation may also be available for certain farm and closely held business real property. This election allows the property to be valued at its actual value, rather than at its fair market value. Certain other elections may be made on this part of the form as well.

Part 4 — General Information

This section includes information about the decedent’s occupation and marital status, along with information about the surviving spouse and the beneficiaries of the estate, such as children and grandchildren. There are also questions about whether gift tax returns have been filed and what types of property were owned by the decedent.

Part 5 — Recapitulation

This is the section where the gross estate and allowable deductions are calculated. Totals from various schedules are entered to make this calculation. Every line must be filled in, even if the entry is 0. Do not enter anything in the Alternate Value column unless the alternate valuation date is elected. Attach the appropriate Schedule for each item in Part 5.

Part 6 — Portability of Deceased Spousal Unused Exclusion Amount (DSUEA)

An election to transfer the unused applicable exclusion amount of the decedent to the surviving spouse can be made here. Also, the DSUEA received by the decedent from a predeceased spouse and applied against lifetime gifts are listed and a total calculated in Part 6.

Schedule A — Real Estate

Provide the address and legal description of all real estate owned by the decedent. If the estate is liable for a mortgage, report the full value of the property in the value column without subtracting the mortgage liability. Show the amount of the mortgage in the description column. The amount of the unpaid mortgage is subtracted on Schedule K.

Schedule B — Stocks and Bonds

Report all stocks and bonds owned by the decedent, including the face amount of bonds, number of shares of stock, unit value, and value as of the date of death (or alternate valuation date, if elected).

Schedule C — Mortgages, Notes, and Cash

Use Schedule C to report mortgages, promissory notes, and cash items held by the decedent at the time of death. Include a description of each item (e.g., the amount of a mortgage, its unpaid balance and the origination date, the borrower and the lender, the location of the mortgaged property, the interest rate). Cash on hand should be reported, as well as the balances of any checking or savings accounts held by the decedent.

Schedule D — Insurance on the Decedent’s Life

Schedule D must be completed if there is insurance on the decedent’s life, regardless of whether it is included in the gross estate. If the decedent possessed any incidents of ownership at death, those policies must be reported, whether the proceeds are payable to the estate (or for the benefit of the estate) or to any other beneficiary.

Schedule E — Jointly Owned Property

All jointly owned property must be reported on Schedule E, regardless of whether the property is included in the gross estate. For the purposes of this form, jointly owned property includes property of any type in which the decedent held an interest as a joint tenant with right of survivorship or as a tenant by the entirety.

Schedule F — Other Miscellaneous Property

Schedule F covers all property included in the gross estate that is not listed elsewhere, such as tangible personal property, business interests, and insurance on the life of another. This schedule must be attached, even if there is no miscellaneous property to report, because it contains questions that must be answered about art, collectibles, bonuses, awards, and safe deposit boxes.

Schedule G — Transfers during Decedent’s Life

The following transfers should be reported on Schedule G:

Gift taxes paid on gifts made by the decedent or the decedent’s spouse within three years before death
Transfer of life insurance policies made within three years before death
Transfer of life estate, reversionary interest, or power to revoke within three years before death
Transfers with retained life estate where the decedent retains the right to designate a beneficiary of the property transferred
Transfers taking effect at death
Revocable transfers

Schedule H — Powers of Appointment

If the decedent possessed any powers of appointment, Schedule H must be completed. A power of appointment means that you have the power to determine who will own or enjoy the property subject to the power. The power must be created by someone other than the decedent. If you answered Yes to line 13 of Part 4, then General Information, Schedule H must also be completed.

Schedule I — Annuities

Annuities owned by the decedent are reported on Schedule I. Any annuity must be included in the gross estate if it meets the following requirements:

It is receivable by a beneficiary following the death of the decedent by virtue of surviving the decedent
It is under contract or agreement entered into after March 3, 1931
It was payable to the decedent, either alone or in conjunction with another, for the decedent’s life, or a period not ascertainable without reference to the decedent’s death, or for a period that did not end before the decedent’s death
The contract or agreement is not an insurance policy on the life of the decedent

Many retirement plan benefits constitute annuities, and Schedule I is the proper place to list these benefits.

Schedule J — Funeral Expenses and Expenses Incurred in Administering Property Subject to Claims

Various deductible expenses and fees associated with managing the estate are itemized on Schedule J. Items to be reported on this form include funeral expenses, executor’s fees, attorney’s fees, certain interest expenses incurred after the decedent’s death, and miscellaneous expenses incurred in preserving and administering the estate.

Schedule K — Debts of the Decedent, and Mortgages and Liens

Debts of the decedent on the date of death are deducted on Schedule K. Debts of the estate incurred after the date of death are not reported on Schedule K.

Schedule L — Net Losses during Administration and Expenses Incurred in Administering Property Not Subject to Claims

Losses that will not be claimed on a federal income tax return are itemized on Schedule L. These items include losses from thefts, fires, storms, shipwrecks, or other casualties that occurred during the settlement of the estate. Expenses other than those listed on Schedule J are also reported on Schedule L, whether these expenses are estimated, agreed upon, or paid.

Schedule M — Bequests, etc., to Surviving Spouse

Property interests passing to the surviving spouse are reported on Schedule M. This item includes property interests the spouse receives by any of the following methods.

As the decedent’s heir, donee, legatee, or devisee
As the decedent’s surviving joint tenant or tenant by the entirety
As beneficiary of life insurance on the decedent’s life
Under dower or curtesy or similar statute
As a transferee of a transfer made by the decedent at any time
As beneficiary of a trust created and funded by the decedent, provided the trust contains certain specified provisions for the spouse

Only property that is included in the decedent’s gross estate can be claimed as a deduction using Schedule M.

Schedule O — Charitable, Public, and Similar Gifts and Bequests

Charitable gifts deducted from the gross estate are itemized on Schedule O. You must also provide a statement that shows the values of all legacies and devises for both charitable and noncharitable use, the date of birth of all life tenants or annuitants, a statement showing the value of all property that is included in the gross estate but does not pass under the will, and any other important information.

Schedule P — Credit for Foreign Death Taxes

If death taxes are being paid to any foreign country, these amounts must be reported on Schedule P to claim a credit against the gross estate. All amounts paid or to be paid for foreign death taxes must be entered in United States currency.

Schedule Q — Credit for Tax on Prior Transfers

If the decedent received property from a transferor who died within 10 years before or 2 years after the decedent, a partial credit is allowable for the taxes paid by the transferor’s estate. This credit is calculated using Schedule Q.

Schedule R — Generation-Skipping Transfer (GST) Tax

Schedule R is used to calculate the generation-skipping transfer (GST) tax that is payable by the estate. GST tax is typically imposed on property transferred to an individual who is two or more generations below the decedent. For purposes of Form 706, property interests being transferred must be includable in the gross estate before they are subject to the GST tax.

Schedule U — Qualified Conservation Easement Exclusion

A portion of the value of land that is subject to a qualified conservation easement may be excluded from a decedent’s gross estate. Schedule U is used to make this election.

Schedule PC — Protective Claim for Refund

Schedule PC can be used to preserve the estate’s right to claim a refund based on the amount of an unresolved claim or expense that may not become deductible under Section 2053 until after the limitation period ends.

Where can you get help filing an estate tax return?

There are many professionals who can assist you in filing an estate tax return, including your attorney, your tax professional, or your financial advisor. In addition, there are now software products designed to guide you through the process of filling out an estate tax return.

To learn more about CapSouth Wealth Management and the services we provide, visit our website at www.capsouthw m.com or call 800.929.1001.

Underestimated Tax Payments

July 23, 2024
Taxes

One of the items that I look at when I review an income tax return for our clients is whether the taxpayer was assessed an underpayment penalty. I have discovered that a lot of clients are not aware of how much these rates have increased and what they can do to reduce the penalty. Hopefully, the following will be helpful to you if you are subject to paying estimated income tax penalties.

First and foremost, remember that the payment of income taxes is a concept of “pay as you go” method. This refers to the system where taxpayers are required to pay their income taxes throughout the year as they earn income, rather than paying the entire amount owed at the end of the tax year.

The Internal Revenue Service imposes penalties for underpaying estimated income taxes throughout the year. These penalties, known as the “estimated tax penalty” or “underpayment penalty,” are calculated separately for each quarter based on the amount of unpaid tax for that period.

How the Penalty is Calculated:

The penalty equals the federal short-term interest rate (in the first month of the quarter in which taxes were not paid) plus 3 percent. As of mid-2024, the estimated tax penalty has reached a whopping 8% – the highest it has been since 2007. This penalty is not deductible, so the effective rate is even higher.

Avoiding the Penalty:

To avoid the underpayment penalty, individuals with an adjusted gross income (AGI) of $150,000 or less must pay by the due date of the tax return the lesser of:

90% of the current year’s tax liability (paid through withholdings or timely quarterly estimates)
100% of the previous year’s tax liability

For those with an AGI above $150,000, the threshold is higher at 110% of the previous year’s tax liability. These amounts can be paid through a combination of withholding from paychecks and timely quarterly estimated tax payments.

It’s important to note that meeting the safe harbor requirement (either 100% or 110% of the previous year’s tax liability) guarantees avoidance of underpayment penalties, regardless of your actual tax liability for the current year. However, if you expect your income to decrease, you may choose to pay 90% of your estimated current year tax liability instead, though this carries more risk of penalties if your estimate is too low

Safe Harbor Rules

The IRS provides “safe harbor” rules that allow taxpayers to avoid the penalty if certain conditions are met, such as:

Owing less than $1,000 in taxes (This is not after estimated or withheld taxes, it is the total tax owed)
Paying at least 90% of the current year’s tax liability through withholdings and timely estimated payments

Notice that taxes withheld from wages & other sources are treated as if they were withheld equally over the year.

- Withholding a large amount from an IRA distribution towards the end of the year does gives you credit for tax payments as if you made them equally throughout the year.
- When you take a taxable distribution from your traditional IRA, you have the option to have federal income tax withheld from the distribution amount. The default withholding rate is 10%, but you can elect to have a different percentage withheld using IRS Form W-4R. The withheld amount is credited against your total tax liability when you file your tax return for that year.
- However, the timing of the withholding does not affect how the payment is credited. Whether you withhold the entire amount in December or spread it out evenly throughout the year, the total withheld will be treated the same way – as a prepayment towards your tax liability for that year. There is no advantage or credit given for making withholding payments earlier in the year.
- The IRS does not consider when the withholding occurred – only the total amount withheld for the tax year. If too little tax is withheld compared to your actual tax liability, you may owe additional taxes plus potential underpayment penalties when you file your return.
- So in summary, while withholding from an IRA distribution can help cover your tax liability, the timing of when that withholding occurs within the tax year is irrelevant. The total amount withheld is simply credited as a prepayment when you file, regardless of whether it was withheld upfront or at the last minute

Quarterly Payment Deadlines

For those required to make estimated tax payments (e.g., self-employed individuals, business owners), the quarterly deadlines are typically:

April 15
June 15
September 15
January 15

However, these dates may be adjusted if they fall on a weekend or holiday. By understanding the estimated tax penalty rules and making timely payments through withholding or estimated payments, taxpayers can minimize or eliminate this costly penalty.

One effective way to minimize or avoid the estimated tax penalty is to use the annualized income installment method. This method allows you to pay estimated taxes based on your actual income earned during each period of the year, rather than having to project your entire year’s income upfront.

The annualized income installment method divides the tax year into four payment periods, with each period using a different income annualization factor:

Period 1 (Jan 1 – Mar 31): Annualize income for this period by multiplying by 4
Period 2 (Jan 1 – May 31): Annualize by multiplying by 2.4
Period 3 (Jan 1 – Aug 31): Annualize by multiplying by 1.5
Period 4 (Jan 1 – Dec 31): No annualization needed for full year

By annualizing your income for each period based on the actual amounts earned, you can make more accurate estimated tax payments that reflect your cash flow. This reduces the likelihood of underpaying and being subject to penalties.

To use this method, you need to complete IRS Form 2210 (Underpayment of Estimated Tax by Individuals) and attach it to your tax return. Be sure to check Box C for “Annualized Income Installment Method” under Part I.

While the annualized method involves more calculations, it provides flexibility for those with fluctuating or seasonal incomes. It ensures you pay the proper estimated taxes based on what you’ve actually earned, rather than an upfront projection.

So, if your income varies significantly throughout the year, strongly consider using the annualized income installment method. It can save you from costly underpayment penalties by aligning your estimated tax payments with your actual earnings pattern.

If you have your tax return prepared by a tax practitioner, be sure to provide them with the information that they will need to use this method. They can determine the amounts from the sale of assets where they have the dates sold. However, for income that you receive a 1099 for, you will have to provide the dates received to them.

Article by: Lewis Robinson, CPA

To further discuss this article, contact Lewis Robinson at LRobinson@capsouthpartners.com

To learn more about CapSouth and the services we provide, visit our website at capsouthwm.com/what-we-do/ or click here to schedule a Discovery Call.

Investment advisory services offered through CapSouth Partners, Inc., dba CapSouth Wealth Management, an independent Registered Investment Advisor. This material has been prepared for planning purposes only and is not intended as specific tax or legal advice. CapSouth Partners does not provide tax or legal advice. Please consult your tax or legal advisor prior to making decisions which may have tax or legal consequences. Information provided by sources deemed to be reliable. CapSouth does not guarantee the accuracy or completeness of the information.

Estate Taxes

February 14, 2024
Estate Planning, Taxes

What are estate taxes?

There are many factors that you should consider when designing an estate plan. One of the most significant is taxes. The act of giving away your property may be subject to taxes on the federal level, state level, or both. These tax liabilities may be the largest potential expenses your estate may have to pay. This means the property that you want to go to your loved ones may go to the federal government and your state instead. Understanding what these taxes are, how they work, how they may affect your estate, and how they can be minimized is vital to implementing a successful estate plan.

While estate taxes technically refers to taxes that are imposed at death, there are two types of taxes that may affect how you plan your estate: (1) transfer taxes and (2) certain income taxes.

Transfer taxes are imposed when you give your property to someone else. This can be done during life (this kind of transfer is called a gift) or at death (this kind of transfer is called a bequest or legacy if you leave a valid will, and intestate succession if you don’t). There are six transfer taxes that may affect your estate: (1) state gift tax, (2) state death taxes, (3) state generation-skipping transfer (GST) tax, (4) federal gift tax, (5) federal estate tax, and (6) federal GST tax. You may also need to know how income taxes affect your estate or your choice of estate planning strategies. There are also three income tax considerations of which you should be aware: (1) income taxation of trusts, (2) your final personal income tax return, and (3) income taxation of your estate.

What are transfer taxes?

A transfer tax is imposed when you give your property to someone else. There are six types of transfer taxes to which you or your estate may be subject.

State gift tax

Currently, only a few states impose a gift tax. A gift is a transfer of property you (the donor) make during your lifetime. The person or organization you give to is called the done. When you make a gift, it is in exchange for nothing, or for property of lesser value. In other words, it is not a bona fide sale. Generally, gifts must be reported and gift taxes paid in the year following the year in which the gift is made (e.g., gift taxes on a gift made in 2023 would be due in 2024). If your state imposes a gift tax and you intend to make lifetime gifts, contact an attorney or your state’s department of revenue or taxation to find out what gifts need to be reported, how to compute the gift tax, and when and how to file a gift tax return.

State death taxes

A state death tax is imposed on property distributed after your death. You should be especially aware of your state’s death tax because it may, in some instances, affect even the smallest estates. There are three types of state death tax.

State generation-skipping transfer (GST) tax

Some states impose a GST tax. The GST tax is imposed on property transferred to a family member who is two or more generations below you (e.g., a grandchild or great-nephew). Contact an attorney or your state’s department of revenue or taxation to find out what transfers may be subject to state GST tax, and when and how to file a return.

Federal gift and estate tax

Generally speaking, federal gift and estate tax is imposed on property transferred to others either while you are living or at the time of your death. Unlike the individual states, the federal tax system is unified. In other words, the IRS adds lifetime and at death transfers and taxes them according to one rate schedule. Here is how the unified tax system works:

Before 1976, the federal tax system worked much like the states. Gifts made during life (taxable gifts) were reported and any gift tax owed was paid on an annual basis. After death, an estate tax was imposed only on property transferred at death (gross estate).

Since 1976, generally, taxable gifts are still reported and any gift tax owed is paid annually. (Generally, you must file a gift tax return and pay the gift tax due, if any, by April 15 of the year following the year in which you make a taxable gift.) But, upon death, all taxable gifts are added to your gross estate for estate tax calculation purposes, even though a gift tax return may already be filed and gift tax paid (gift tax paid is deducted from estate tax owed, if any).

Congress unified the gift tax and estate tax systems so that (1) you can’t avoid estate tax by giving your wealth away before you die and (2) you pay taxes on the cumulative amount of wealth you give away (this pushes your estate into a higher tax bracket).

You need a basic understanding of the unified tax system so that you can (1) estimate your estate tax liability and (2) minimize your estate taxes using an estate freeze technique. An estate freeze technique is any planning device that allows you to freeze the present value of your estate and shift any future growth to your successors. Understanding how your estate tax liability is calculated and the variety of techniques you can employ to freeze your estate may help you:

Save your property for your beneficiaries: Estate tax rates could reach as high as 40 percent for the estates of persons dying in 2024. This means that a large chunk of your estate may go to the IRS instead of your loved ones. If you want to preserve your estate for your beneficiaries, you need to know how to keep your property from being subject to estate taxes.
Reduce estate tax liability: Under the unified tax system, you are allowed a basic (applicable) exclusion amount that reduces your gift tax/estate tax liability. Additionally, there are exclusions, deductions, and other credits available that allow you to pass a certain amount of your estate free from tax. You need to understand what these exclusions, deductions, and credits are and how they work in order to take full advantage of them. Another method of reducing your estate tax liability is to prevent any further growth in the value of any appreciating assets that you own from being taxed to your estate. Estate freeze techniques range from relatively simple (e.g., installment sale or private annuity) to the more complex (e.g., gift- or sale-leaseback). You need to know what these techniques are and how they are used in order to know which, if any, is best for you.
Provide for payment of estate taxes: Generally, estate taxes must be paid within nine months after your death. In order to avoid depriving your beneficiaries of what you intend for them to receive, you should provide that specific and sufficient assets be set aside and used for this purpose. In addition, these assets should be sufficiently liquid to pay this expense when it is due.

Plan for estate tax expense: Although calculating estate taxes can be complex, you should estimate what the amount of your estate taxes may be so that you can arrange to replace the wealth that is lost if you have specific gifts you would like to make.

Federal generation-skipping transfer (GST) tax

Like the state-imposed GST tax, the federal GST tax is imposed on property you transfer to an individual who is two or more generations below you (e.g., a grandchild or great-nephew). The tax code is drafted to levy a tax on property as it is passed from generation to generation at each and every level. The purpose of the GST tax is to keep families from avoiding estate taxes by skipping an intermediate generation. A flat tax rate equal to the highest estate tax rate then in effect is imposed on every generation-skipping transfer you make over a certain amount.

What are certain federal income taxes that you should know about?

There are three federal income tax considerations of which you should be aware:

Income taxation of trusts

If your plan includes the use of a trust, you need to know that a trust may be a taxpaying entity. The trustee may be required to file an annual return and pay income tax on the trust income.

Decedent’s final income tax return

You may earn income during the year in which you die. If so, your personal representative will need to file your final income tax return (both federal and state) and pay any income tax that may be owed. The funds to pay the income tax will be paid from your estate. Your tax year ends on the date of your death.

Income taxation of your estate

Your estate is considered a separate tax-paying entity by the IRS. Your personal representative must file and pay income tax on any income your estate receives (e.g., interest from bonds or dividends from stock).

To further discuss this article contact us at 800.929.1001. To learn more about CapSouth and how we help, visit our website at CapSouthWM.com