22.2 Federal Estate Tax (Form 706), Gross Estate Valuation, Deductions & DSUE Portability Election

Federal Estate Tax Framework & Filing Thresholds (IRC Chapter 11)

The federal estate tax, codified in Internal Revenue Code (IRC) §§ 2001 through 2210, is an excise tax imposed on the transfer of the taxable estate of every decedent who is a citizen or resident of the United States. Unlike an inheritance tax—which is imposed by certain states on the recipient's privilege of receiving assets—the federal estate tax is imposed on the decedent's estate for the privilege of transferring property at death.

Mandatory Filing Threshold for 2025 Decedents

Under IRC §6018(a), a federal estate tax return (Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return) must be filed by the executor if the decedent's gross estate plus adjusted taxable gifts (taxable gifts made after December 31, 1976, that are not included in the gross estate) exceeds the basic exclusion amount for the calendar year of death.

Form 706 Filing Trigger Formula (2025 Decedents):
Gross Estate (Valued at Date of Death or Alternate Valuation Date)
Plus: Adjusted Taxable Gifts (Post-1976 Taxable Gifts under §2001(b))
If Total > $13,990,000  -->  Form 706 MUST Be Filed

For decedents dying in calendar year 2025, the basic exclusion amount is $13,990,000 (indexed for inflation under IRC §2010(c)(3); up from $13,610,000 in 2024). Even if no estate tax is ultimately owed due to the unlimited marital or charitable deductions, Form 706 is legally mandatory if the gross estate plus adjusted gifts exceeds the $13,990,000 threshold.

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Defining the Gross Estate (IRC §§ 2031 through 2044)

The gross estate includes the fair market value of all property, real or personal, tangible or intangible, wherever situated, in which the decedent had an interest at the time of death (IRC §2031 and §2033). The tax concept of the gross estate is significantly broader than the probate estate:

Life Insurance Proceeds & Incidents of Ownership (IRC §2042 / §2035)

Life insurance on the decedent's life is among the most heavily tested areas on the EA exam. Proceeds paid to named beneficiaries (e.g., adult children) are included in the gross estate if the decedent possessed any "incidents of ownership" at death (IRC §2042(2)). Incidents of ownership include the economic power to:

• Change or designate the beneficiary
• Surrender, cancel, or terminate the policy
• Assign the policy or revoke an assignment
• Pledge the policy as collateral for a loan
• Borrow against the cash surrender value

The Three-Year Rule for Life Insurance Transfers (IRC §2035(a)): If an individual owns an existing life insurance policy on their own life and transfers that policy (e.g., to an Irrevocable Life Insurance Trust / ILIT, or outright to an adult child) and dies within three years of the transfer date, 100% of the death proceeds are pulled back into the decedent's gross estate. If the individual survives the transfer by more than three years, the proceeds escape the gross estate entirely.

Joint Tenancy with Right of Survivorship: Spousal vs. Non-Spousal (IRC §2040)

• Qualified Joint Interest between Spouses (IRC §2040(b)): If property is held solely by spouses as tenants by the entirety or as joint tenants with right of survivorship, exactly 50% of the value is included in the gross estate of the first spouse to die, regardless of which spouse paid for the asset.
• Non-Spousal Joint Tenancies (IRC §2040(a)): For joint tenancies between unmarried individuals (e.g., parent and child, or siblings), the "consideration furnished rule" applies. The rebuttable presumption is that 100% of the asset's value is included in the deceased joint tenant's gross estate, unless the executor proves by affirmative records that the surviving co-owner contributed original funds not gifted or acquired from the decedent.

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Valuation: Date-of-Death FMV vs. Alternate Valuation Date (IRC §2032)

Assets in the gross estate are generally valued at their fair market value (FMV) as of the date of the decedent's death (IRC §2031). Under Treasury Regulation §20.2031-1(b), FMV is the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts.

The Alternate Valuation Date (AVD) Election (IRC §2032)

To provide relief to estates whose assets decline sharply in value immediately following the decedent's death, the executor may make an irrevocable election on Form 706 to value all estate assets on the Alternate Valuation Date (AVD), which is exactly six months after the date of death.

Statutory Prerequisites for AVD Election: Under IRC §2032(c), the AVD election is permitted only if the election decreases BOTH:

1. The value of the gross estate; and
2. The sum of the federal estate tax and generation-skipping transfer (GST) tax (reduced by allowable credits).

[!CAUTION] The Zero-Tax Trap: If a decedent's estate incurs zero federal estate tax due to the unlimited marital deduction or because the gross estate is below the basic exclusion amount, the AVD election cannot be made, even if asset values dropped precipitously! Because there is no estate tax to decrease, the second statutory requirement is not satisfied.

AVD Valuation Rules:

• Assets Retained: Valued as of the date exactly 6 months after death.
• Assets Sold, Distributed, or Disposed of Within 6 Months: Valued as of the exact date of sale, distribution, or disposition (IRC §2032(a)(1)).
• Assets Affected by Mere Lapse of Time: Assets whose values change simply due to the passage of time (such as patents, life estates, remainder interests, or annuities) are valued as of the date of death, with adjustment only for value changes not attributable to the lapse of time (IRC §2032(a)(3)).

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Allowable Estate Deductions (IRC §§ 2053 through 2058)

The gross estate is reduced by statutory deductions to arrive at the taxable estate (IRC §2051):

Taxable Estate Computation:
Gross Estate (Date of Death FMV or AVD)
Less: Funeral Expenses (§2053(a)(1))
Less: Administrative Expenses (Legal, Accounting, Appraisal, Executor Fees - §2053(a)(2))
Less: Debts and Claims Against the Estate (§2053(a)(3))
Less: Unpaid Mortgages and Liens on Included Property (§2053(a)(4))
Less: Casualty and Theft Losses Incurred During Administration (§2054)
Less: Unlimited Marital Deduction (§2056)
Less: Unlimited Charitable Deduction (§2055)
Less: State Death Taxes Paid (§2058)
Equals: Taxable Estate (IRC §2051)

Double Deduction Prohibition (IRC §642(g))

Under IRC §642(g), amounts allowable under IRC §2053 (administrative expenses such as executor commissions, attorney fees, and accounting expenses) or IRC §2054 (casualty/theft losses) cannot be deducted on both Form 706 and the fiduciary income tax return (Form 1041). The executor must elect where to claim these deductions:

• To claim administrative expenses on Form 1041 to offset fiduciary income, the executor must file a written statement waiving the right to claim them on Form 706.
• The executor may split expenses between the returns in any proportion desired (e.g., 60% on Form 706 and 40% on Form 1041).
• Funeral Expenses: Funeral expenses may only be deducted on Form 706; they are strictly personal expenses and can never be deducted on Form 1041.

The Unlimited Marital Deduction & Non-Citizen Spouses (IRC §2056 & §2056A)

• Citizen Spouse: Property passing outright from the decedent to a surviving spouse who is a U.S. citizen qualifies for a 100% unlimited marital deduction (IRC §2056(a)).
• Non-Citizen Spouse & QDOT: Under IRC §2056(d)(1), the marital deduction is disallowed if the surviving spouse is not a U.S. citizen, unless the property passes into a Qualified Domestic Trust (QDOT) under IRC §2056A. A QDOT requires at least one trustee to be an individual U.S. citizen or domestic corporation, and estate tax is paid whenever principal distributions are made to the non-citizen spouse during life or upon the spouse's death.

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Computation of Estate Tax & Portability (IRC §2010)

Once the taxable estate is determined, federal estate tax is calculated:

1. Add Adjusted Taxable Gifts: Taxable gifts made after December 31, 1976 (other than gifts included in the gross estate) are added to the taxable estate to yield the tentative tax base.
2. Calculate Tentative Tax: Apply the progressive rate schedule of IRC §2001(c) (top rate 40% for amounts over $1,000,000).
3. Subtract Gift Taxes Payable: Subtract gift taxes that would have been payable on post-1976 gifts using current tax rates.
4. Subtract Unified Credit: Subtract the applicable credit amount for 2025: $5,541,800 (which fully offsets tax on $13,990,000).

Portability of Deceased Spousal Unused Exclusion (DSUE) (IRC §2010(c)(5))

"Portability" allows a surviving spouse to elect to add the deceased spouse's remaining unused basic exclusion amount (known as the Deceased Spousal Unused Exclusion, or DSUE) to the surviving spouse's own basic exclusion amount.

• Mandatory Election on Form 706: The portability election is not automatic. It can only be made by timely filing a complete federal estate tax return (Form 706) on behalf of the deceased spouse's estate, even if the estate is otherwise below the filing threshold.
• Filing Deadline: Form 706 is due 9 months after the date of death. An automatic 6-month extension to file is obtained by submitting Form 4768 prior to the 9-month deadline.
• Revenue Procedure 2022-32 (Five-Year Relief Window): Many smaller estates fail to file Form 706 within 9 months because no tax was due. Rev. Proc. 2022-32 provides simplified late-filing relief: if an estate was not otherwise legally required to file Form 706 (gross estate plus adjusted gifts did not exceed the filing threshold), the executor has up to five years after the decedent's death to file Form 706 solely to elect DSUE portability, without paying user fees or requesting a private letter ruling (PLR).
• The "Last Deceased Spouse" Rule: Under IRC §2010(c)(4)(B), a surviving spouse may only use the DSUE of their most recently deceased spouse. If Widow Jane inherits a $5,000,000 DSUE from Husband 1, subsequently marries Husband 2, and Husband 2 predeceases Jane leaving zero DSUE, Husband 1's DSUE is completely extinguished.