Estate tax and transfers

Estate tax

The estate tax is a federal tax on the transfer of a decedent’s property at death, based on the fair market value of everything the decedent owned or controlled at death. That reaches beyond the probate estate: property that passes outside probate, such as jointly owned property that goes to the survivor or life insurance payable to a named beneficiary, can still be included. The tax is computed by starting with the gross estate, subtracting allowable deductions to reach the taxable estate, and then figuring the tax on the taxable estate (plus adjusted taxable gifts) using the unified rate schedule and subtracting the applicable credit for the basic exclusion amount ($13,990,000 for 2025).

Upon a taxpayer’s death, any income the decedent had already constructively received is reported on the decedent’s final Form 1040 for the year of death. Income the decedent had a right to but had not yet constructively received (income in respect of a decedent) is reported by whoever receives it: on Form 1041 if the estate receives it, or on the beneficiary’s own return if the right passes directly to a beneficiary. The estate’s executor is responsible for collecting the decedent’s assets, paying the decedent’s debts and obligations, then distributing the remaining assets to the heirs. The executor is also the one who must pay the estate tax (IRC §2002), using the estate’s assets, so the heirs generally receive what is left rather than paying the tax themselves.

Definitions

Gross estate

The total fair market value of all property owned or controlled by a decedent at the time of death, before deductions. It includes real estate, bank accounts, investments, business interests, retirement accounts, and life insurance proceeds, and forms the starting point for calculating estate tax liability.

Form 1041

The U.S. Income Tax Return for Estates and Trusts, filed to report income earned by an estate or trust - including interest, dividends, capital gains, rental income, and business income - for tax years beginning after the decedent’s death.

Joint tenants with right of survivorship

The gross estate includes 50% of property held as joint tenants by spouses or as tenants by the entirety regardless of the amount of consideration provided by each spouse, as long as the surviving spouse is a U.S. citizen. If the surviving spouse isn’t a U.S. citizen, this 50% rule doesn’t apply, and the amount included depends on how much of the purchase price each spouse provided. In a community property state, only the decedent’s half of the community property is included.

Definitions

Joint tenancy with right of survivorship

A form of co-ownership in which two or more people hold equal shares of property. When one owner dies, their share automatically passes to the surviving owner(s) outside of probate.

Tenants by the entirety

A form of joint ownership available only to married couples in which both spouses own the entire property together. Neither spouse can sell or transfer their interest without the other’s consent, and the property passes automatically to the survivor upon death.

Life insurance and retirement accounts

Insurance on the decedent’s life is included in the gross estate, at the full amount of the proceeds, when it is:

• Payable to the estate: receivable by the executor or for the estate’s benefit, such as proceeds the beneficiary is legally bound to use to pay the estate’s taxes or debts, even if someone else paid the premiums; or
• Payable to another beneficiary, if the decedent held any incident of ownership at death: the right to change the beneficiary, to surrender or cancel the policy, to assign it, or to pledge it or borrow against it, or a reversionary interest worth more than 5% of the policy’s value.

Giving the policy away doesn’t remove it if the decedent dies within 3 years of the transfer: the proceeds are pulled back into the gross estate. Insurance is reported on Schedule D of Form 706. Proceeds that are free of income tax to the beneficiary (Gift tax and life insurance) can still be subject to estate tax.

An IRA or retirement plan balance payable to a beneficiary because the owner died is included in the gross estate (Schedule I). Insurance or an account that passes to a U.S. citizen surviving spouse or to charity still qualifies for the marital or charitable deduction. A traditional IRA or plan balance is also income in respect of a decedent: the beneficiary pays income tax on distributions of the pre-tax balance and can deduct the federal estate tax attributable to that income under section 691(c), only as an itemized deduction on Schedule A, line 16 (Individual and itemized deductions lists it).

Dower and curtesy

The gross estate includes the full value of the decedent’s property even though it may be subject to the surviving spouse’s dower or curtesy interest - that interest does not reduce what’s includible (IRC §2034). Dower entitles a surviving wife to a portion of property her husband owned and possessed during their marriage. Curtesy entitles a surviving husband to a life estate in his wife’s land if they had children.

Form 1041: who files and when

Form 1041 (the estate’s income tax return) is required if the estate:

• Has gross income of $600 or more for the year.
• Has a nonresident alien beneficiary.
• Has a qualified investment in a qualified opportunity fund (QOF)

Form 1041 is due on the 15th day of the fourth month following the end of the tax year (April 15th for calendar year entities). Form 7004 gives an automatic 5 1/2 month extension. This due date and extension are separate from Form 706’s, covered below.

Estate tax and income tax deductions

Exempt from Form 706 estate tax

• Assets passing to a surviving spouse who is a U.S. citizen (unlimited marital deduction). The marital deduction has no dollar limit. Property left to a surviving spouse who isn’t a U.S. citizen qualifies only if it passes to a qualified domestic trust (QDOT), which defers the estate tax rather than eliminating it.

Form 706 (estate tax) deductions

• State estate, inheritance, legacy, or succession taxes paid (Form 706, line 3b)
• Funeral and administration expenses, debts and mortgages, and losses during administration (Schedules J, K, and L)
• Charitable bequests (Schedule O)

Foreign death taxes paid are a credit against the estate tax (Schedule P), not a deduction.

Form 1041 (estate income tax) deductions

• The estate’s or trust’s exemption amount
• Losses on the sale of investments (investment advisory fees that an individual investor would also pay are not deductible)
• Ordinary and necessary expenses that are common and accepted in the trust or estate’s trade or business (the cost of additions or improvements to property is capitalized and added to basis, not deducted)
• Expenses that are helpful and appropriate to the trust or estate’s business.
• The income distribution deduction: income distributed to beneficiaries is deducted by the estate or trust and reported to them on Schedule K-1, but only up to distributable net income (DNI).

Definitions

Dower

A common-law right entitling a surviving wife to a portion of real property her husband owned during their marriage, regardless of what his will states.

Curtesy

A common-law right entitling a surviving husband to a life estate in his wife’s real property if they had children together during the marriage.

Qualified opportunity fund (QOF)

An investment vehicle organized as a corporation or partnership to invest in eligible property located in a qualified opportunity zone. Taxpayers who invest capital gains in a QOF may defer or reduce those gains, incentivizing investment in economically distressed communities.

Fiduciary accounting income

Fiduciary accounting income refers to the income available for distribution from a trust or estate, which is calculated based on the trust’s receipts and disbursements. Receipts such as proceeds from selling a trust asset are generally allocated to principal (corpus) rather than income, so a distribution of principal to a beneficiary is not a distribution of FAI.

Definitions

Fiduciary accounting income (FAI)

The income of a trust or estate that is available for distribution to beneficiaries, calculated based on the entity’s receipts and disbursements as defined by the governing document and applicable state law. FAI determines how income is allocated between income beneficiaries and remainder beneficiaries.

FAI includes:

• Interest and dividends
• Net profit from a business or farm
• Rental income

FAI does not include:

• Capital gains/losses
• §1245 and §1250 recapture
• Net losses from business or farm
• Liquidation distributions
• Income in respect to a decedent

Excess of deductions and capital loss carryovers pass through to beneficiaries on final Schedule K-1.

Alternate valuation election

An alternate valuation election can be made only if it reduces both the gross estate’s value and the estate’s tax liability. When it is elected, property is valued six months after death, except that property sold, distributed, or otherwise disposed of during those six months is valued on the date of disposition. Assets that can change in value include but are not limited to securities, real property, installment notes, inventory, and accounts receivable. The election must be made on a timely filed Form 706, or a late return filed no more than one year after its due date.

Definitions

Alternate valuation date

An option available to an estate to value assets six months after the date of death rather than on the date of death, if doing so would reduce both the gross estate value and the estate tax liability. The election is made on Form 706.

Form 706 - United States estate and generation-skipping transfer tax return

Used to report the value of the decedent’s estate and calculate any estate tax liability, including generation-skipping transfer (GST) tax.

Filing requirement: Generally, if the gross estate, plus adjusted taxable gifts and specific exemption, exceeds the estate tax exemption threshold for the year of death. For example, for decedents who died in 2025, Form 706 must be filed if the gross estate plus adjusted taxable gifts and specific exemption is more than $13,990,000. The due date is nine months after the decedent’s date of death; Form 4768 gives an automatic six-month extension of time to file. The alternate valuation date is a separate matter: it is six months after death, and the executor elects it on Form 706.

Definitions

Generation-skipping transfer (GST) tax

A federal tax imposed on transfers of property to individuals who are two or more generations younger than the donor (such as grandchildren), either directly or through a trust. The GST tax is imposed in addition to any gift or estate tax and is designed to prevent wealthy families from avoiding transfer taxes by skipping a generation.

Deceased spousal unused exclusion (DSUE)

After December 31, 2010, a deceased spouse’s estate may elect to pass any of the decedent’s unused federal estate tax exemption to the surviving spouse, who can then apply it toward their own future gift or estate taxes. This is called the deceased spousal unused exclusion (DSUE) or portability election. The DSUE amount is the deceased spouse’s unused exclusion: up to $13,990,000 for a spouse who died in 2025, reduced by whatever the deceased spouse’s estate and lifetime taxable gifts used.

• Federal estate taxes apply to an estate larger than $13.99 million per person (2025). Anything over that amount is taxed at a rate of up to 40%. The exact percentage is based on the taxable amount of the estate. State estate and inheritance taxes vary by state; tax rates can be as high as 35% (Washington, for deaths on or after July 1, 2025).

Definitions

DSUE (Deceased spousal unused exclusion)

The unused portion of a deceased spouse’s federal estate and gift tax exemption that can be transferred to the surviving spouse through a portability election, allowing the survivor to apply both exemptions to their own future transfers.

Portability election

The election made on Form 706 that allows a surviving spouse to use the deceased spouse’s unused estate tax exemption. The election must be made by filing Form 706 within nine months of the decedent’s date of death (or by the extended due date); an estate not otherwise required to file can elect up to five years after death under Rev. Proc. 2022-32.

Gift tax - including the annual exclusion, gift-splitting, and Form 709 - is covered in the next chapter, Gift tax and life insurance.