Thursday, 29 February 2024

Estate planning: Death and taxes

Only death and taxes are certain; sometimes they even come together. So everyone should know some basic tax issues associated with inheritances.


The taxes potentially involved are federal estate taxes, federal and state personal income taxes, federal and state fiduciary income taxes, and local real property taxes. Let’s examine them separately.


Federal estate taxes now only affect persons transferring more than $3.5 million at death to their surviving family, excluding gifts left to the surviving spouse – there is an unlimited marital deduction for transfers to surviving spouses.


The $3.5 million is the net worth of the decedent considering all assets, including life insurance. Also, a generation skipping transfer tax may apply when more than $3.5 million is left to related persons more than one generation younger than the decedent (e.g., grandchildren), unless the intervening generation has predeceased the decedent, or is left to unrelated persons who are more than 37.5 years younger.


What about personal income tax? Personal income tax only applies to transfers of items of income in respect of a decedent (IRD).


What is IRD? IRD is anything that would have been included as ordinary income on the decedent’s annual tax return, if received while alive.


Examples include unpaid retirement monies (such as IRAs, annuities, and 401(k)s) and earned but unpaid compensation. Not included as IRD is life insurance. The proceeds are not subject to income tax unless an exception to the “no taxation” of life insurance proceeds applies.


The receipt of property – other than IRD – is not income taxable; there is, however, often an income tax opportunity for the beneficiary who receives property from a decedent. Specifically, any appreciation in value that occurred while the decedent owned the property is eliminated at death and will not be subject to capital gains income tax. That is, the beneficiary receives a so-called “step up in basis” based on date of death appraisal.


For example, if the decedent bought his house in 1970 for $75,000, the decedent had a purchase cost basis of $75,000. If he dies on June 25, 2009, when it is worth $250,000 and leaves it all to his son, then the son’s basis for income tax purposes is stepped up to $250,000, thus eliminating all $175,000 of appreciation when the son sells.


If a deceased person’s estate is held within a trust or probate estate, then a so-called fiduciary income tax return is usually required, and taxes may be due at the estate level. Because trusts pay taxes at the highest graduated rate once their taxable income reaches around $11,000, it is prudent to distribute the taxable income out to the beneficiaries prior to the trust’s own tax year end to avoid paying higher trust tax rates. Taxation of trusts is a very complex, so rely on a qualified tax expert here.


Next, death can trigger a reassessment in value for local (county) real property taxes. With the exceptions of the interspousal transfer exclusion and parent child transfer exclusion for transfers of one’s primary residence and up to one million dollars in other additional real property to surviving children (and sometimes grandchildren), all other transfers trigger a reassessment in tax value to the recipient at time of transfer.


Accordingly, when a decedent’s estate consists of real property and other substantial assets and one child wants to receive a particular real property asset, there is a planning opportunity if the real property in question is left directly by the parent to that child.


Otherwise, if that child buys out his or her siblings, then the portion that is purchased from the other siblings will be reassessed, as there is no exclusion for transfers between siblings.


In conclusion, there are numerous tax opportunities and pitfalls to be considered carefully when planning and subsequently administering a person’s estate.


Dennis A. Fordham, attorney (LL.M. tax studies), is a State Bar Certified Specialist in Estate Planning, Probate and Trust Law. His office is at 55 1st St., Lakeport, California. Dennis can be reached by e-mail at This email address is being protected from spambots. You need JavaScript enabled to view it. or by phone at 707-263-3235.

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