Estate Planning: Tax Considerations

State Taxes on Estates and Inheritances

The federal estate tax rules apply to everyone in America. Some states also impose various taxes that effect estates or inheritances. Some states charge an additional estate tax similar to the national one, and some impose an inheritance tax. (Inheritance taxes are charged to beneficiaries, estate taxes to a person's estate.) Some states impose a separate gift tax, on top of the federal gift tax. (Gift taxes are imposed upon gifts made above a certain amount; see below.) What's taxed and at what rate depends on the law of the state you live in for intangible personal property, whenever located, and of the state in which it is located for real estate and tangible personal property. Some states have only a "pick-up" tax, which is equal to the maximum credit the Internal Revenue Code allows to the taxpayer for state inheritance taxes.

Unless your state has an inheritance tax, your beneficiaries don't pay tax when they receive money from your estate. But they will have to pay income tax on any earnings after they invest the bequest.

Capital Gains Taxes

Death itself produces a large amount of extraordinary expenditures for taxes, expenses of administering the estate, and frequently the forced early payment of outstanding debts. To obtain the cash for such payments, sales of assets are frequently made, and if the sale is for more than the date-of-death value, it may trigger a capital gains tax at the time of sale. The asset selected for sale is critical, as the tax may be deferred or accelerated depending on present or future anticipated tax brackets.

Employee Benefits

Payments under company-deferred compensation and pension plans produce a bewildering array of possible choices (lump sum, installments, etc.), with differing income and estate tax results. The federal estate tax may not apply to some employer-provided annuities or death benefits paid to your beneficiaries. Social Security payments to your dependents are not subject to federal estate tax.

Proceeds from pensions and benefit plans generally pass directly to whomever is named as a beneficiary in those plans. If, however, the proceeds are payable to the deceased's estate, they are part of the gross estate for estate tax purposes. You need to ask your lawyer or accountant about the possible tax consequences of your particular plan.

Taxes on Insurance Benefits

Many states impose an inheritance or estate tax on insurance proceeds payable to the estate, and may also do so if insurance proceeds are payable to a named beneficiary, including the trustee of either a living trust or a trust created by a will, as long as the decedent owned this policy or held incidents of ownership (see below). (The proceeds of an insurance policy paid to a named beneficiary are exempt from all federal income taxes, and almost all state income taxes except to the extent that they include interest.)

You can save on estate taxes by transferring ownership of your life insurance policy to a trust that meets certain requirements. This means the value of the proceeds won't be included in your estate. However, you must follow strict requirements:

• The life insurance trust must be irrevocable.
• You cannot retain any kind of ownership (incidents of ownership), such as-making decisions about the policy, or name yourself trustee.
• You must transfer the ownership at least three years before you die; otherwise, the proceeds will be taxed as part of your estate. The three-year rule doesn't apply if you were never the owner of the policy; for example, you could originally take out the policy in the name of the trust or of your spouse.

---

Page 2 of 2 Prev Page

---

Copyright 1999, 2000, 2002 American Bar Association