Taxability of Potential Inheritance

cheerful1_gwMay 15, 2007

DH's stepmother is 83. She recently changed ownership of her accounts (savings, brokerage) to herself, jointly with DH. She has written, notarized instructions to DH as to where the money goes after her death (split among the grandchildren, with remainder to us). She also has an IRA with DH as sole beneficiary. My question is: what is the taxability to all involved?

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I would think it would depend on what state you are living in AND what her will says.

    Bookmark   May 15, 2007 at 3:39PM
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You need to talk to a tax advisor, fast. Asking for free help from strangers with unknown credentials is worth exactly what you pay for it.

    Bookmark   May 15, 2007 at 3:44PM
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Proviso: I know next to nothing about U.S. tax laws.

I think that there may be a good possibility that, when she changed the ownership of her brokerage holdings (stocks, mutual funds, etc.) it may be what they call a "deemed disposition", as though she'd sold them and bought them again with her and the other person as joint owners. Which could well mean that she'd be tax-liable on the amount of capital gain (net of deductions for losses) that she'd built up during the time that she held them.

Quite likely rules will vary by State, so you need advice relevant for your State.

I agree that you need to talk to someone familiar with the tax laws in your jurisdiction ... and it might be well to consult her/your lawyer, and an estate planner, as well. Especially if the holdings are substantial ... and if your husband is to turn over a substantial amount to others.

If you aren't familiar with such professionals, ask around among people whose judgement that you trust for some suggestions and referrals.

A skilled advisor might well save your MIL a substantial amount.

Good wishes as you consider what may be the ideal solution.

ole joyful

    Bookmark   May 15, 2007 at 6:38PM
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I agree with jkom - you need a tax advisor or lawyer. If there's a will that says one thing and accounts held jointly saying something else there could be more problems than any tax liability. If your DH holds joint ownership on all his Stepmother's assets, at her death those assets are his.

Get some good and reliable counsel.

    Bookmark   May 16, 2007 at 1:43AM
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She does not have a will, and I know my DH will honor her wishes for distribution of the funds. My concern was with the taxability of what the beneficiaries will receive. I can ask a tax advisor. Thanks to all for the advice.

    Bookmark   May 16, 2007 at 6:55AM
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It's SUCH a pain in the a$$ for the survivors when things are done this way, I can't tell you. I know some older people are paranoid about making a will--my MIL has the notion that the lawyer will take a percentage of everything she has--but it really is SO much better.

My grandmother had a will, but for whatever reason left everything to my mother, w/ instructions to turn over a certain amount to my brother and me. It took YEARS, because of the gift tax laws. It was so ridiculous.

If your step-MIL refuses to write a will, then encourage her to open joint accounts w/ everyone she wants to give money to. That way there's no gift tax and your DH doesn't have the potential of getting all the relatives mad at him because they think they're being shortchanged (just read thru the archives here to see how well family relations and money go together).

    Bookmark   May 16, 2007 at 12:48PM
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My dad went the Revocable Trust route and when he passed my sister and I had no trouble aside from various institutions requiring different forms of notarization, etc. That reminds me, I need to get one set up to make life easier on my heirs.....

    Bookmark   May 16, 2007 at 2:34PM
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My MIL for years didn't want to pay a lawyer to set up her estate. She had written a perfectly valid will. But once her mortality was staring her in the face she was willing to pay the money to consult an attorney specializing in estate law. His advice was invaluable, and made it much easier to distribute her estate according to her wishes.

I'm glad you're talking to a tax advisor. It's possible that her written notarized instructions do constitute a will, and in the worst possible case, your DH would end up paying out all of the inheritance tax, distributing the bequests, and end up with nothing himself - not at all what his stepmom apparently wants. (Who knows what inheritance taxes will be in effect at the time of her death?)

It would help the tax advisor if you know the value of the accounts. As you know, that will make a big difference in the tax issues.

    Bookmark   May 16, 2007 at 2:38PM
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The advice here came from people in various jurisdictions ... and may not apply where you live.

You really need to talk to folks who know the financial game, tax laws, wills and estates, etc. in your jurisdiction.

Especially if substantial or complicated assets are involved.

ole joyful

    Bookmark   May 17, 2007 at 12:41PM
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Our family has found the revocable trust route the best -- AND a will! Best get a trust in place; they have to be in existance a certain number of months/years to be valid at the originator's death.

    Bookmark   May 17, 2007 at 5:16PM
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" My question is: what is the taxability to all involved?"

I would be more concerned about liability. If your stepmother DOESN'T have a will, the state will probably step in and that could delay distribution of any assets. Plus, what if either DH or the stepmother is involved in an accident or lawsuit? The injured party could go after either for recompense.

The advice to consult a tax advisor is good. An Estate Planning CPA (in your area) will be able to answer all of your tax questions as well as refer you to an attorney who could help set up a trust.

A link that might be useful-
Preventing squabbles over a will with no-contest clause

"Make your own living trust"
by attorney Denis Clifford. Nolo press He also writes the book "Plan your estate". boards/estate planning-trusts

    Bookmark   May 18, 2007 at 12:47PM
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Isn't there also the taxation issue to the OP's dh because the assets are also in his name?

I remember hearing that elderly parents should not put their house in the name of anyone else because when they die and the other owners go to sell, they have to pay huge capital gains taxes.

I think it's a huge mistake to have someone else's name on accounts when taxation is likely.

She should have a will and a trust and get your dh's name off the accounts, otherwise, when he goes to withdraw the money to distribute to the other heirs, HE will be taxed on it.

Of course, YMMV and talk to a lawyer/tax advisor.

Aside: Inheritences are not taxable (depending on the state) to those who receive them. Since your dh's name is on those accounts and she doesn't have a will, it's not considered an inheritence.

    Bookmark   May 19, 2007 at 3:57PM
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Hopefully the way it will work is: of the money sitting in the accounts, we will set aside 15% for capital gains tax, then pay funeral expenses, then give $5,000 to each beneficiary (none are her blood relatives). My husband and I get the rest.

"(just read thru the archives here to see how well family relations and money go together)". I know that very well.

    Bookmark   October 24, 2007 at 10:21AM
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You need to talk to a lawyer. Here's why.

Once your DH's stepmother changed ownership of the account to a joint account, that removed it from the inheritance. When she dies, that just decreases the number of owners of the account by one, and it becomes your DH's account.

Suppose he honors his stepmother's wishes and distributes that account to various people. Then I would imagine that he will owe gift taxes on each transfer that exceeds the limits. For that matter, I wouldn't be surprised if there were tax issues when she made him part owner of the account, and it may be that she already owes gift taxes on that account.

The time to resolve this matter is before the IRS comes knocking at the door.

    Bookmark   October 24, 2007 at 11:07AM
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>>Aside: Inheritences are not taxable (depending on the state) to those who receive them. Since your dh's name is on those accounts and she doesn't have a will, it's not considered an inheritence.That is certainly not true in the state of CA. Anytime someone dies, their assets are part of an estate inherited by someone - whether the joint owner, or otherwise specified heirs. If there is no will or joint ownership, the "rule of inheritance", known as "per stirpes" (which differs by state, BTW), will be followed.

And more states are instituting estate taxes, especially as RE and sales tax revenues fall.

The true issue is the overall size of the estate and how the state of domicile treats community and joint property. The federal estate tax limits are $2M for 2007/8, $3.5M for 2009, and unlimited for 2010. In 2011 it goes back down to $600K UNLESS Congress does something - which they doubtless will, but there are no guarantees on exactly WHAT they will do. In light of the burgeoning deficits (where oh where did our little budget surplus go?) it is a safe assumption the estate tax will continue, but at a higher level than the old $600K limit.

The estate is liable for the taxability of all gifts made on its behalf, prior to final disbursement. Once inherited, it becomes part of the heir's estate, counted in with the heir's personal assets. Whatever gifts the heir distributes, are his/her tax responsibility.

Realistically, if the gifts are going to total LESS than the federal estate tax limit for whatever year the Estate Owner dies, there is no tax due on either donor or receiver end.

For instance, my MIL's estate is less than $1M. She can give her son $200K, file a report on the gift with the IRS, and nobody will owe any tax even when she dies. Her estate falls under the federal estate tax limits unless Congress does nothing and the limits revert back to the old $600K limit in 2011 and beyond. So as you can see, much depends on WHEN the person owning the assets dies, thus adding to the uncertainty of planning for the future.

If you have a very large estate, one way to disburse an inheritance is to use the gift tax laws, currently $12,000 per person. You can even top-load by giving up to five years' of exclusion amounts at one time. In this example, a fond grandparent would disburse $60K for each grandchild, perhaps by funding a 529 plan for each child. In this way, with five grandkids, $300K is removed from the estate for federal estate tax purposes (for the next five yrs; after that they can start gifting again), with no tax liability to anyone. If both grandparents are alive they could each give $12K x 5 and remove $600K from the taxable estate, no small sum.

They would want to do this if their estate is large enough that it will trigger estate taxes no matter what Congress does - although if the federal estate tax is eliminated, that strategy becomes unnecessary and I would expect they would revisit the inheritance scenario at that time.

As far as the IRA is concerned, she is taking her mandatory distributions, called RMD. Upon inheriting the IRA, your DH should NOT roll this money into his own IRA, but keep it separate. He is required to continue taking the RMDs based upon HIS life expectancy, and yes he will pay income taxes on this. He cannot avoid taxes by rolling it over to his children; the tax liability will only shift to them - but there may be other legal issues here, so he would definitely need to speak to a tax advisor about this. I don't know how one could disclaim an IRA to pass it on to other heirs, but your DH should specifically request the details on how to "stretch" an IRA (that's the technical term, if I recall correctly).

Your DH should also remember that there are tax consequences to liquidating the taxable assets of anyone, including an estate. Any profits ARE taxable and no distributions to heirs should be made until the final tax return for the estate is done. In that manner the estate will pay the income tax, not the heir.

    Bookmark   October 24, 2007 at 12:41PM
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>>Your DH should also remember that there are tax consequences to liquidating the taxable assets of anyone, including an estate. Any profits ARE taxable and no distributions to heirs should be made until the final tax return for the estate is done.I forgot one important thing - the executor of an estate may need to know the "original cost basis" for the assets in order to calculate the gains. This can be a real 'bear' because financial institutions cannot and do not keep these records. It is completely the responsibility of the owner of the assets - and can entail some frantic searches through mounds of old papers in order to settle this issue.

Again, this is something your tax advisor should discuss with you. Better to be forewarned that you will need this stuff, rather than attempting to deal with it after the fact!

    Bookmark   October 24, 2007 at 12:47PM
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