Extrajudicial settlement of estate serves as the primary non-judicial mechanism for heirs to partition and transfer properties left by a deceased person under Philippine law. Governed primarily by Rule 74 of the Rules of Court, this process applies when the decedent dies intestate, leaves no outstanding debts (or all debts have been settled), and the heirs— all of legal age or duly represented if minors—execute a public instrument dividing the estate. The deed must be published in a newspaper of general circulation once a week for three consecutive weeks to bind third parties. Upon registration with the Register of Deeds, title transfers directly from the decedent to the heirs.

While efficient and less costly than judicial partition, extrajudicial settlement carries significant tax consequences under the National Internal Revenue Code (NIRC) of 1997, as amended by Republic Act No. 10963 (TRAIN Law). The two principal taxes involved are estate tax, which arises from the transmission of property at death, and donor’s tax, which may be triggered by gratuitous transfers or renunciations among heirs during the settlement process.

Legal Foundations

Estate tax is imposed under Section 84 of the NIRC on the net estate of every decedent, whether citizen, resident alien, or non-resident alien. It is a tax on the privilege to transmit property upon death, not on the receipt by the heirs. The TRAIN Law simplified the regime by imposing a flat rate of six percent (6%) on the net estate, replacing the previous progressive rates.

Donor’s tax, under Section 98 and 99 of the NIRC, is likewise a flat 6% tax on the net gifts made during the calendar year in excess of ₱250,000. It applies to transfers of property inter vivos made gratuitously. In the context of extrajudicial settlement, donor’s tax arises when the settlement deed effects a gratuitous disposition of hereditary rights beyond the heirs’ legal or testamentary shares.

Both taxes must be settled before clear title can be transferred, as the Bureau of Internal Revenue (BIR) issues a Certificate Authorizing Registration (CAR) only upon full payment or satisfactory arrangement. Without the CAR, the Register of Deeds will not register the deed of extrajudicial settlement.

Estate Tax in Extrajudicial Settlements

Liability and Timing
The estate tax accrues at the moment of death and is the solidary liability of the heirs, executor, or administrator. In extrajudicial settlement, the heirs assume this responsibility collectively. The estate tax return (BIR Form 1801) must be filed, and the tax paid, within one (1) year from the date of death. The Commissioner of Internal Revenue may grant a reasonable extension not exceeding two (2) years for meritorious cases, provided a bond is posted if the extension exceeds one year.

Payment of estate tax is a condition precedent to the valid registration of the extrajudicial settlement deed for real properties. Heirs typically secure the CAR before or simultaneously with the execution of the deed.

Computation of Net Estate
For citizens and resident aliens, the net estate is computed as follows:

Gross Estate
− Allowable Deductions
= Net Estate
× 6%
= Estate Tax Due

Gross Estate includes all real and personal property, tangible or intangible, situated in the Philippines (and worldwide for residents), valued at fair market value at the time of death. For real properties, the higher of the zonal value or the fair market value per the latest tax declaration applies. Personal properties are valued at market value, with special rules for shares of stock (book value or par value depending on listing) and other assets.

Allowable Deductions (Citizens and Residents)

Standard deduction: ₱5,000,000 (this simplified deduction replaced the former itemized funeral and judicial expenses).
Family home: up to ₱10,000,000, provided it is the decedent’s actual family residence, duly certified, and claimed by the surviving spouse or heirs. Only one family home qualifies.
Net share of the surviving spouse in the conjugal or community property (this is deducted after determining the gross estate but before computing the net taxable estate).
Vanishing deduction (property previously taxed) on properties inherited within five years prior to death, with percentages decreasing over time (100% if within 1 year, down to 20% in the 5th year).
Claims against the estate (unpaid debts, loans, and mortgages substantiated by documents).
Claims against insolvent persons.
Unpaid mortgages, liens, or encumbrances on property.
Casualty losses (not compensated by insurance) occurring during the settlement period but within the allowable window.
Transfers for public use (to the Government or accredited entities).

Medical expenses incurred by the decedent within one year prior to death are no longer deductible following the TRAIN Law amendments.

For non-resident aliens, only properties situated in the Philippines are included in the gross estate. Deductions are allowed proportionately based on the ratio of Philippine gross estate to worldwide gross estate, without the standard deduction or family home deduction.

The net share of the surviving spouse is always excluded from the taxable estate, as it represents the spouse’s conjugal or community interest, not part of the decedent’s transmissible estate.

Special Rules in Extrajudicial Settlement
In practice, the heirs prepare a detailed inventory of assets and liabilities. The estate tax is often paid from estate funds or advanced by the heirs pro-rata according to their shares. Once paid and the CAR obtained, the deed of extrajudicial settlement can be executed and registered. The CAR explicitly authorizes the transfer of the properties from the decedent’s name to the heirs.

Failure to pay estate tax within the prescribed period triggers a 25% surcharge (50% if fraudulent), plus interest at the prevailing legal rate (currently aligned with double the Bangko Sentral ng Pilipinas rate or as prescribed), and possible compromise penalties.

Donor’s Tax in Extrajudicial Settlements

When Donor’s Tax Arises
Estate tax covers the transmission from decedent to heirs. Any subsequent gratuitous transfer among the heirs within the settlement deed constitutes a separate taxable donation.

The most common trigger is the inclusion in the deed of extrajudicial settlement of a clause whereby one or more heirs “waive,” “renounce,” or “cede” their hereditary share in favor of one or more specific co-heirs. Philippine tax authorities treat such specific renunciation as a donation inter vivos subject to donor’s tax.

General vs. Specific Renunciation

General renunciation: The heir simply refuses the inheritance without designating any beneficiary. The share accrues to the other heirs by operation of law (intestate succession rules). This is generally not treated as a taxable donation by the renouncing heir, as no active transfer occurs.
Specific renunciation: The heir expressly renounces the share in favor of a named co-heir or third person. This is substantively a donation. The BIR consistently rules that the renouncing heir becomes the donor, and the recipient becomes the donee. The value of the renounced share (or the excess value received) is subject to 6% donor’s tax.

Even in the absence of explicit waiver language, if the adjudication of properties results in one heir receiving property whose fair market value exceeds his or her proportionate hereditary share without monetary consideration, the BIR may recharacterize the excess as a taxable donation.

Valuation and Timing
The donor’s tax is computed based on the fair market value of the donated property at the time of the donation—typically the date of execution and notarization of the deed of extrajudicial settlement or the separate deed of waiver. This differs from estate tax valuation, which freezes at the date of death. If real property has appreciated between death and settlement, the donor’s tax will capture the increase in value.

Computation
Total net gifts during the calendar year
− ₱250,000 annual exemption
= Taxable net gifts
× 6%
= Donor’s tax due

Deductions from gross gifts include any mortgage or encumbrance assumed by the donee. Gifts to the same donee across multiple deeds in one year are aggregated. The donor (renouncing heir) files BIR Form 1800 and pays the tax within thirty (30) days from the date of the donation.

Practical Application in Settlement Deeds
Many extrajudicial settlement deeds combine partition and waiver provisions. To minimize disputes:

Clearly state each heir’s legal share.
If a waiver occurs, specify the recipient and the exact property or portion waived.
Compute and pay donor’s tax on the waived portion separately.
Request separate CARs: one for the estate tax (decedent to all heirs) and another for the donor’s tax (donor-heir to recipient-heir).

The BIR may require submission of the published deed, inventory, and proof of payment of both taxes when processing the CAR application.

Procedural Integration of Both Taxes

Inventory and Valuation — Heirs compile a complete list of assets and liabilities, obtaining current zonal values and tax declarations.
Estate Tax Compliance — File BIR Form 1801, pay the tax (or secure extension), and obtain the estate tax CAR.
Execution of Deed — Draft the deed of extrajudicial settlement, incorporating any waivers. Notarize the deed and publish it.
Donor’s Tax Compliance (if applicable) — The waiving heir files BIR Form 1800 within 30 days and pays the donor’s tax, securing a separate CAR.
Registration — Present the deed(s), CAR(s), and other requirements (death certificate, birth certificates of heirs, etc.) to the Register of Deeds. Pay documentary stamp tax on the conveyance (generally ₱15 for every ₱1,000 of the higher of consideration or fair market value) and local transfer taxes.
Issuance of New Titles — The properties are transferred to the named heirs or recipients.

Common Issues and Compliance Pitfalls

Delayed Settlement: Executing the deed years after death exposes any waived portion to donor’s tax on appreciated values.
Ambiguous Deed Language: Vague waiver clauses invite BIR assessment of donor’s tax on the entire excess value received.
Unequal Adjudication Without Consideration: Assigning higher-value properties to one heir without payment or adjustment is presumed a donation to the extent of the excess.
Conjugal vs. Exclusive Properties: Failure to properly segregate the surviving spouse’s conjugal share can lead to overpayment of estate tax or disputes.
Minors or Represented Heirs: Court approval may be needed for the minor’s share, complicating the extrajudicial nature.
Testate Estates: Strictly, Rule 74 applies to intestate estates. If a will exists, probate is generally required, though heirs sometimes execute extrajudicial settlements by agreement. This carries legal risk, but tax obligations (estate tax plus potential donor’s tax on deviations from the will) remain.

Special Considerations

Donations to Strangers vs. Relatives: Since the TRAIN Law, the 6% flat rate applies regardless of relationship. No higher rate for strangers.
Exempt Donations: Certain donations (e.g., to accredited donee institutions for public purpose) are exempt, but such transfers are rare in standard family extrajudicial settlements.
Sale Instead of Donation: If the renouncing heir receives consideration equal to the value of the share, the transaction becomes a sale subject to capital gains tax (6% on the gross selling price or zonal value, whichever higher) rather than donor’s tax.
Small Estates: For estates valued at ₱500,000 or less (summary settlement under Rule 74, Section 2), simplified procedures apply, but estate tax rules remain the same.
Non-Resident Decedents: Limited to Philippine-situs properties; donor’s tax may still apply to subsequent transfers of those properties by resident heirs.

Proper documentation, accurate valuation, and timely payment of both estate tax and any applicable donor’s tax are essential to secure clean title and avoid assessments, surcharges, interest, and potential criminal liability for tax evasion. The interplay between these taxes underscores the importance of careful drafting of the settlement deed to reflect the true intent of the heirs while complying with substantive tax rules.