Estates Must File New Tax Form to Avoid Penalties

Update (3/24/16): The IRS has extended the filing deadline from March 31, 2016, to June 30, 2016, for IRS Form 8971 and corresponding Schedule A.

Effective immediately, executors of certain estates are required to report the estate tax value of property distributed to beneficiaries on new IRS Form 8971. In addition, a Schedule A to Form 8971 must be delivered to each beneficiary. For some estates, the filing deadline of March 31, 2016, has recently been extended to June 30, 2016. Failure to file timely will result in penalties.

The purpose of these new rules is to ensure consistency between property values reported on the estate tax return and the income tax basis that beneficiaries use in calculating gain or loss on subsequent sales of inherited property. Basis of property inherited from a decedent may not exceed the value of the property reported for estate tax purposes.

Penalties for non-compliance

If the executor fails to timely file an accurate Form 8971 or Schedule A and does not show reasonable cause, the IRS may impose penalties. Penalties can range from a modest $50 per Form 8971 to a whopping $3,193,000 per year, according to the IRS’ instructions. However, the Form 8971 instructions don’t explain how the penalty will be calculated.

Furthermore, a beneficiary who reports basis in property that is inconsistent with the amount shown on his or her Schedule A may be liable for a 20 percent accuracy-related penalty.

The prudent course of action is to file these forms timely and accurately.

To which estates and property do the rules apply?

Form 8971 must be filed by any estate that is required, after July 31, 2015, to file a Form 706, federal estate tax return (or a Form 706-NA, federal estate tax return for a nonresident/noncitizen). Generally, this includes large estates for which the value of the decedent’s assets exceeded his or her remaining estate tax exemption. For decedents who died in 2015, the estate tax exemption was $5.43 million, less lifetime taxable gifts.

If an estate is not required to file an estate tax return but files one anyway, the estate does not need to file a Form 8971. The most common example is when the executor files an estate tax return to elect portability, which permits the surviving spouse to utilize the remaining estate tax exemption of the first spouse to die.

Moreover, there are some types of property that are not required to be reported on a Form 8971 or Schedule A, namely cash, retirement accounts, tangible personal property of modest value and property that is sold by the estate and, therefore, not distributed to the beneficiaries.

Exceptions to basis consistency requirement

Property that qualifies for the estate tax charitable deduction or marital deduction is not subject to the basis consistency requirement. Thus, in most cases where a charity or spouse inherits property (either outright or in certain trusts), the charity or spouse will not be bound to using the Schedule A values as their income tax basis.

Nevertheless, the executor still must include charitable and marital bequest property on Form 8971 and issue Schedules A to the charity or spouse (or their trusts).

When is the filing deadline?

Generally, an estate that is required to file Form 8971 and Schedules A must do so by the earlier of (a) 30 days after the estate tax return was required to be filed (including extensions, if any) and (b) 30 days after the estate tax return was actually filed. However, the IRS just extended the due date to June 30, 2016, for those estates that would otherwise be required to file on or before June 30, 2016.

The rules are complicated

The guidelines for properly preparing Form 8971 and Schedule A are wrought with complications and exceptions that are beyond the scope of this article. Executors are encouraged to consult a qualified tax preparer immediately, to determine whether these forms must be filed to avoid penalties.