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Young couple filing their taxesWhen someone passes away, what the person passes down to his or her beneficiaries may be subject to federal estate taxes. If the decedent “skips” a generation in passing along assets then it may trigger a tax bill. IRS Form 706 is used to calculate the potential tax liability from these so-called generation-skipping gifts. In this article, we’ll define what Form 706 is, explore how to calculate taxes owed and explain how to file the form. Try using SmartAsset’s free financial advisor matching tool to get paired with advisors in your area.

What Is IRS Form 706?

IRS Form 706 is used to calculate the taxes owed for two situations – estate taxes and generation-skipping transfers. Both of these situations can trigger a tax liability and the form must be submitted separately from your tax returns.

Current tax laws allow for an estate tax exemption of $11.7 million (2021 limit). This limit is based on the value of the decedent’s assets, not the decedent’s net worth. Estates that are valued below this limit have no federal estate tax liability.

With estate tax rates of up to 40%, these tax bills can be devastating, especially if the deceased owed money against those assets. While most families are not affected by estate taxes, those that are should work with a financial planner to create a strategy to reduce its impact.

Generation-skipping transfer taxes may be owed when a decedent skips a generation when naming their beneficiaries. For example, when someone skips their child and names their grandchild as the beneficiary to some or all of their estate. This tax can also be triggered when leaving assets to someone more than 37.5 years younger than you.

The second version of 706 is called Form 706-NA. This version is used to calculate estate taxes for beneficiaries who are non-resident aliens of the United States.

How to Calculate the Value of an Estate

Combine these numbers and compare them against the estate tax exemption limit to determine if you must file an estate tax return.

  • Value of the decedent’s estate at the time of death. This is the gross value of the estate. No adjustments are made for liabilities (aka net worth).
  • Taxable gifts made by the decedent that exceeded the annual gift tax exclusion after Dec. 31, 1976.
  • Total specific exemption allowed under Section 2521 for gifts made after Sept. 8, 1976.

Even if no federal estate taxes are owed, Form 706 must be filed if the gross value of the estate is more than the exemption limit.

Who Must File Form 706?

Form 706 is filed on behalf of a deceased person whose gross estate, specific exemptions and adjusted taxable gifts are higher than the estate tax exemption limits. Usually, this form is filed by the executor of the estate.

When does it need to be filed?

The form must be filed within nine months of the date of the decedent’s death.

Payments for taxes due for Form 706

Taxes owed are also due within nine months of the date of the decedent’s death. You may elect to pay the taxes in installments if you cannot pay all at once. Payments may be made by check payable to “United States Treasury” or electronically through the Electronic Federal Tax Payment System (EFTPS).

How to file an extension for estate taxes

If you are unable to file or pay your tax liability by this deadline, you may request an extension by submitting Form 4768. This form provides an automatic six-month extension to file Form 706.

Where to file Form 706

Form 706 cannot be filed electronically. This form must be printed out and mailed to:

Department of the Treasury
Internal Revenue Service
Kansas City, MO 64999

IRS instructions for Form 706 provides additional addresses if you are using a private delivery service or filing an amended form.

Reducing Estate Taxes and GSTs

Instead of waiting until you pass away to give money to your beneficiaries, you can help them out while you’re still alive. Certain payments are excluded from taxes and will not affect your lifetime gift exemption.

  • Annual gifts. You and your spouse are both eligible to give up to $15,000 per year (2021 limits) to each individual person. Recipients do not have to be related to you. This annual gift limit is adjusted for inflation every year. For a couple with a married child and two grandchildren, each person can gift a total of $60,000 each year (a total of $120,000 for the couple). That would be $15,000 each to their child, spouse and two grandchildren.
  • Paying tuition. When you pay tuition directly to the institution, these amounts are given without affecting estate or gift taxes. This exemption only covers tuition. Room and board, supplies, books and other costs are not eligible.
  • Covering medical expenses. Paying medical expenses directly to the provider or medical facility can be done without affecting estate taxes or triggering gift taxes.

Form 709 – When Gifts Exceed the Annual Limit

A CPA prepares a client's tax returnsWhile the annual gift limit allows you to give up to $15,000 (2021 limit) to anyone without triggering a gift tax, you can actually give more than that if you like. Examples of larger gifts include a down payment for a child’s house, funds deposited into a 529 Plan, or forgiving a loan that you’ve made. For gifts that exceed $15,000, you must file Form 709 with your annual tax returns. Making a gift that exceeds this limit does not mean that you’ll owe gift taxes. Instead, this form keeps track of the taxable gifts you’ve made during your lifetime. These excess amounts above the annual gift limit are subtracted from your lifetime estate tax and GST exemption limits when you pass away.

However, if you gift something to someone for less than its fair market value, you may owe gift taxes on Form 709. For example, let’s say that you transfer a home to your child for less than its value. You would owe gift taxes on the difference between the property’s fair market value and what was actually paid.

The Bottom Line

IRS officeHigh-valued estates and gifts that skip a generation may require a Form 706. This form determines whether or not federal taxes are owed on a decedent’s gifts to beneficiaries. Strategic planning with a financial advisor and certain eligible gifts throughout your lifetime can help to reduce the impact of estate and gift taxes owed. Additionally, these forms may be complicated for the average person. Involving a tax advisor is a prudent step to avoid incorrectly filling out the form and triggering an unnecessary tax bill.

Tips on Tax Filing

  • Investors should strongly consider working with a financial advisor to develop plans to mitigate the effect of estate taxes on their portfolios. Such advisors can provide guidance and offer solutions that are customized to your specific situation. Finding advisors doesn’t have to be hard. The SmartAsset matching tool can connect you in minutes with professionals in your local area. If you’re ready, get started now.
  • Inflation can be a hidden enemy of fixed income investors. Our inflation calculator helps investors understand how rising costs can impact the buying power of their money over time.

Photo credit: ©iStock.com/skynesher, ©iStock.com/ridvan_celik, ©iStock.com/Pgiam

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