Transfer on Death Tax Implications

Receiving an inheritance can be an unexpected windfall. Although if you get stocks and securities through a transfer on death account, don’t be surprised when your gift has a tax bill attached.

A transfer on death account is a popular estate planning tools designed to avoid probate by naming a beneficiary to a brokerage account. However, it doesn’t avoid taxes. In fact, transfer on death accounts are exposed to all the same income and capital gains taxes when the account owner is alive, as well as estate and inheritance taxes upon the owner’s death.

Before setting-up a transfer on death account, you should review the tax implications of these accounts.

Income Taxes

During your lifetime, you have full ownership and control of assets in a transfer on death account. You can manage the investments as you see fit, make additions or withdrawals, and even close the account if you wish. Since you receive all interest, dividends or other income, you’re responsible for taxes on any income.

Estate Taxes

When someone dies and their property transfers to their beneficiaries, the federal government impose an estate tax on the value of all that property. Since the transfer on death account is not a trust, it does not help you avoid or minimize estate taxes. The IRS requires those passing in 2016 or later with estates exceeding $5.45 million in assets to pay estate taxes. Unless this threshold is reached, there is no IRS filing requirement.

Only a handful of states collect estate taxes. Of the states that impose their own tax, the value of the estate must exceed the tax exemption value before any taxes are owed.

Inheritance Taxes

An inheritance tax is a state-imposed tax that you pay when receiving money or property from a deceased person’s estate. Fortunately, these taxes are almost a thing of the past. Only a handful of states still collect an inheritance tax. Those states with a tax, have a relatively high threshold before taxes are due. Unlike an estate tax, beneficiaries pay the inheritance tax and it is usually due shortly after funds are received by the beneficiary.

Depending on your relationship to the deceased, you may qualify for an exemption or reduction in the amount of inheritance tax owed. For example, most states exempt a spouse who inherits property from their deceased spouse.

Capital Gains Taxes

Transfer on death accounts may offer capital gains benefits. If you have appreciated stocks in your brokerage account and sold them before your death, you would owe a tax on any profits (capital gains) earned. Simply put, capital gains are the difference between the sale price of an investment and the original purchase price (the tax basis) of that investment.

When you created a transfer on death account by naming a beneficiary to your brokerage account, the laws sets the inheritor’s tax basis as the value at the time of the previous owner’s date of death.

For example, imagine you purchased 1,000 share of stock for $10 each. Several years later the stock is valued at $75 a share. If you sold the stock, you’d owe a capital gains tax on $65 profit per share or $65,000. With a transfer on death account, your beneficiary receives stock valued at $75 a share. If he sells the stock for that price, no capital gains is owed because he sold an asset valued at $75 for its face value.

Paying the Estate’s Taxes with Account Funds

When you die death, your estate administrator will likely need to file your last tax return. If you owe estate or income taxes, these will need to be paid before distributions are made to your beneficiaries. Before you set up a transfer on death account, be sure there are other funds available to pay your final costs.

State law may require the beneficiary to contribute toward the payment of the estate tax or inheritance tax bill when the estate does not have other funds available. A few states allow you to place instructions in your will or living trust that require the transfer on death account beneficiary to use those funds to cover any tax liability.

Still have Questions, Receive a Free Case Review

Transfer on death accounts are an efficient, probate-avoiding method for distributing the securities you own. Since State law, rather than federal law, governs the way securities may be transferred at death, designing a tax-efficient estate plan is a challenge. Consulting with an experienced attorney can help prevent tax headaches down the road. Receive a free case review to better understand what works best for your situation.

Next Steps

Contact a qualified estate planning attorney to help with the probate process.

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