There’s no doubt about it: estate planning can be complicated! Even with the guidance of a trusted estate planning attorney and a CPA, tackling all the right things at exactly the right time can be challenging—especially amid the emotional rollercoaster that often follows the death of a family member. That’s even more true for those fortunate to have achieved higher levels of wealth.
Recently, the IRS changed a tax rule that may help ease that burden—at least a small amount. As of July 8, 2022, the timeline for filing Form 706 is extended from 2 years to 5 years. Form 706 is used to make an estate tax portability election that allows a surviving spouse to claim and use the deceased spouse’s unused estate and gift exclusion amount (DSUE) for gift and estate tax purposes. The exclusion matters as it can significantly increase the total amount of inherited assets that is exempt from the 40% estate/gift tax otherwise imposed on assets over $12.06 million (as of 2022). If your assets aren’t at that level, don’t stop reading! The limit also applies to total lifetime assets, so if there is potential for inherited wealth to exceed the limit during the surviving spouse’s life, it is still a wise move to file Form 706 on time to lock in the exemption for the future.
While 2 years may sound like more than enough time to handle such important paperwork, the IRS had good reason to make the change: their data showed that surviving spouses often missed the deadline, increasing their tax consequences significantly. We watched this possibility play out firsthand at LCM when one of our clients lost her husband to COVID early in the pandemic. Making funeral and other arrangements during lockdown was incredibly challenging, but Form 706 simply couldn’t wait. That meant that she and her son were forced to focus on the paperwork, a daunting task that includes filing an estate tax return—a mandatory prerequisite for filing the form. With the help of a wonderful estate planning attorney and CPA working in tandem, they were able to file on time, but having a 5-year window would have given them 3 added years of breathing room to tackle the paperwork and protect their family assets.
Even with the help of a trusted estate planning attorney and CPA, deciding whether to file Form 706 and completing the actual task can be far less than straightforward. For starters, though the window to file Form 706 is now 5 years, the deadline to file the prerequisite estate tax return is 9 months following the date of death. Plus, because this return is not required by most estates, some forethought may be needed to determine if filing is necessary. In short, if you fail to file the estate tax return on time, you forgo the option of filing Form 706. Even if you’re uncertain whether you will need the portability option later, filing a return may be in your best interest because it keeps the option open for 5 years should you or your advisor decide you need it.
If your inheritance is less than the exemption amount of $12.06 million (in which case no estate taxes would be due), it can be easy to assume that Form 706 is unnecessary. Yet it’s still possible that you will want the exemption in 10 or 20 years after your inherited assets have had time to grow.
For example, let’s say you are the beneficiary of $8 million following the death of your spouse. At more than $4 million below the estate tax exemption limit, you may think there’s no reason to file Form 706. Not filing means that the remaining amount of the lifetime exemption cannot be added to your own exemption at a later date. Looking to the future, however, may change that assessment. Assuming you didn’t draw from your lump sum inheritance, an average market return of 10% per year could potentially push your assets over the current limit in just over 5 years. If you did not file Form 706 on time (and the estate tax return required to do so) and you were to die with assets above your own limit, your own beneficiaries would have to pay the 40% tax rate on those additional inherited assets. If your assets were to grow significantly between the time of your spouse’s death and your own, you could end up leaving an abundance of assets behind—as well as a large, unnecessary tax bill for your loved ones.
At LCM, our goal is to help families grow and protect their legacies. Failing to plan for that growth can create tax issues that deplete that legacy for future generations. For individuals and families with multiple millions of dollars in assets, Form 706 is something that should always be considered with the help of a knowledgeable estate planning attorney and is generally filed by a certified public accountant. While our team doesn’t provide legal or tax advice ourselves, we are happy to point you to an estate planning attorney in our professional network if you would like more detailed information on the new regulation and how Form 706 may help protect your own family wealth. We also recommend reading The Estate Tax and Lifetime Gifting from Charles Schwab to learn more about this important topic. The complexity of the process is unlikely to change, but at least the extended timeline will make tackling the paperwork a bit easier for the surviving spouse and family members to manage when the time comes.