The Tax Implications of an Estate
What are the Tax Implications if I Inherit, or am the Executor of an Estate?
There are times in life when asking questions is just the smart thing to do.
Until our tax codes are simplified, to answer a tax implication question can be time consuming and confusing.
Whether it is a simple Will, or a Will and a Trust it’s best to get informed advice.
The following are some frequently asked tax questions from clients who have inherited assets or are charged with disbursing someone’s assets after their death.
Q: My father died in January and through a trust, he left me as the named beneficiary on an insurance policy, an IRA account and some stocks. What are my tax implications?
A: First, the beneficiary of a trust is not taxed. It is the giver who pays the tax, through the trust, if taxes are due.
What You Need to Know
- Life insurance to the named beneficiary is not taxed and goes directly to the beneficiary without going through probate, no matter the size of the policy.
- As with the life insurance a named beneficiary for an IRA keeps it out of probate, however there will be tax implications. You can’t treat an inherited traditional IRA, from anyone other than a deceased spouse, as though it were your own. This means, if you are the beneficiary you cannot make any contributions to the IRA or roll over any amounts into or out of the inherited IRA.
You can, as the beneficiary make a trustee-to-trustee transfer, as long as the IRA into which the amounts are being moved is set up and maintained in the name of the deceased IRA owner for the benefit of the beneficiary. You will not owe tax on the assets in the IRA until you start receiving distributions from it.
If your father had already begun taking distributions from it, then you will need to continue that and depending on your age, there could be tax implications.
- The stock, or any other assets like stocks, have to be appraised at market value at the date of death. So, you say the stock’s market value is $262,500 and your father purchased the stock at $100 a share. At his death, the stock was valued at $175, you are eligible to get a step-up in basis. That means if you sold the stock a few months later and it was worth $180 a share, you would only pay the difference in value of $5, rather than $80. Also, in California, probate is required for assets of $150,000 or more, however, since these assets were in a revocable trust, that became irrevocable on his death with you as the named beneficiary, the stocks will not need to go through probate.
Q: My sister died without a will or a trust, but she named me and my sister as equal beneficiaries to her life insurance, an IRA and Disney stock. I was also designated as the Executor of her estate. She had a modest bank account, but owed on a credit card, so the bank funds went to pay the credit card debt. The disbursements were made, but a final tax return for her was never filed. I’m feeling guilty and wonder what I can to do to rectify that?
A: If she died in February of 2016, and did not file in 2015 you will need to do a little research, unless you have her last tax return available.
What You Need to Know
- You will need to request information using the form 4506-T, Request for Transcript of Tax Return from the IRS. See Getting Information from the IRS first, before you file a request for transcript.
- Additional documents you might need include W-2s and 1099s.
Remember These Tips
Assets with named beneficiaries such as life insurance policies and retirement accounts don’t need to be included in a trust.
Why? Because they pass to the beneficiaries in a pay-on-death process automatically, once they receive proper documentation.
- However, if a named beneficiary is under 18, defining how the funds will be transferred and handled for the child and the designation of a guardian or guardians should be included in your will and trust.
- If you are inclined to name a trust as the beneficiary of a retirement account get some solid tax advice first, as it could accelerate taxes on proceeds from an IRA.
A trust does not take the place of a will.
Aside from the very real need to protect any intangible assets, like patents, intellectual property or literary rights, you still need a will in addition to a trust, period. This is an important point and one that many people don’t realize.
Did you know that throughout your lifetime there will be many events that have the potential to complicate your tax status?
Having the proper plans in place now can make the difference between messy and easy when it comes to how your beneficiaries will handle your estate.
Some life changing events that have tax ramifications are:
- Purchase of a home
- Birth or adoption of a child
- Opening a new brokerage account
- Separation or divorce
- Death of a spouse, partner or heir
No one wants to have their beneficiaries go through the lengthy probate process. Yet, according to a recent study by Care.com, more than half of US adults have no will or estate planning documents.
Only 42% have decided to make plans to protect their heirs or beneficiaries. Even more surprising, that same study showed, for adults with children under the age of 18, only 36% have wills or estate planning in place.
Trusts Minimize the Need to Go Through Probate
A good estate planning attorney, with detailed information supplied by your Enrolled Agent or tax advisor, can factor in the tax implications for your specific situation.
Keep Your Tax Advisor in the Loop
The laws concerning tax implications are always changing and no one understands them better than your tax advisor. We can help you and your family with the accounting associated with a trust.