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estate tax

Pre-Death Planning: Roth Conversion

Jan 25th, 2012
by jblankenship.
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Eilaine Roth
Image via Wikipedia

Financial planning often requires us to face our own certain demise – something that we often don’t want to do, but still a certainty that we all must face.

Among the things that we want to do when planning for the inevitable would be to make certain that our surviving loved ones have access to adequate monetary resources to support themselves, in the most cost-effective manner.  Another thing that we hope to accomplish is to make the transition as easy as possible for our loved ones.  One way to do this is to convert a good portion of your IRA or other tax-deferred funds to a Roth IRA account.  Here’s why:

By converting to a Roth account, you will make the funds in that account available to your heirs totally tax free.

Granted, your estate will also be smaller by the amount of tax that you paid on the conversion.  At the same time, your heirs will also not have to go through the rather painstaking process of managing the IRD deduction, if the estate is of a size that requires estate tax to be paid.  This will simplify the overall process dramatically, and depending upon the size of your overall estate this could be a significant.

On the downside of this, it’s likely that if you convert your account in a single year the tax paid on the conversion would be much, much higher than if your heirs paid tax on the ordinary required distributions if the account is left as a traditional IRA.

However, if you converted your account over several years in smaller amounts using a strategy like filling up the brackets, the overall tax cost of the conversion will be less, maybe even less than the cost that your heirs would experience otherwise.

You can always use recharacterization strategies to make sure that the whole process is as tax-efficient as possible. And in today’s tax climate (and market volatility) there are literally very few reasons not to go ahead with a Roth conversion strategy.

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A Beneficiary Designation Dilemma

Oct 12th, 2011
by jblankenship.
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Qtips
Image by Ben Saren via Flickr

Since families today are different and more complicated from the traditional situation, with ex-spouses, children from first and subsequent marriages, and children from unions where a marriage didn’t take place, designating beneficiaries for IRA accounts can be very complex.

For example, it’s not out of the question for an individual to have re-married later in life and have children from an earlier marriage. In addition, the new spouse could have children from his or her previous marriage.  And then possibly children resulting from the current marriage.

So, this individual might wish to leave the proceeds of his IRA to his or her current spouse first and foremost at his or her passing – but then to split the remainder of the account among his or her children from the first marriage and the children from the second marriage equally. If you know anything about how IRA beneficiary designation forms work, this situation likely couldn’t be accomplished using that simple form.  You need something more…

QTIP Trust

The tool you’re looking for here is a QTIP trust.  No, it has nothing to do with a stick with cotton on the end of it or any bathroom product for that matter, QTIP stands for Qualified Terminal Interest Property.  This QTIP trust is a special sort of trust that allows an individual to leave the income from their assets to a spouse and then, at the death of the surviving spouse the remaining principle is passed on to the beneficiaries designated by the original owner of the account(s).  In this fashion the children from the previous marriage have protection of the assets that they would eventually receive.

If a vehicle such as a QTIP trust isn’t used, then the current spouse could take control of the account and either use up all of the assets, or change the beneficiaries to only include his or her own children, excluding the children from the former marriage.

QTIPs are very complicated to put into use, since there are a lot of moving parts, beneficiaries, and a considerable amount of time could elapse from the time it is put into play (the first death) and the death of the surviving spouse.  The distribution process from the IRA is also complicated, since using a trust as a beneficiary takes away the designated beneficiary from the process, meaning that the account would be distributed to the trust within five years, as an example.

It’s best to make sure you’ve got an attorney who specializes in estate planning and IRAs to help with the process. But if you have a situation like the one described (or even more complicated) the QTIP trust may be your best bet to accomplish what you’d like to do with your IRA.  Incidentally, other assets besides an IRA could be put into a QTIP trust as well, for the same purpose.

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IRAs and Blended Families

May 3rd, 2010
by jblankenship.
1 comment

mountain dew bust a cap by Steve SnodgrassIn today’s society, the historically “traditional” family is becoming less and less commonplace – apparently as many as 50% of all children under age 13 are currently living with one biological parent and that parent’s current partner who is not a biological parent of the child.  Often as well, there is a significant age differential between the biological parent and the parent’s partner.  Even if there is little difference in ages, quite often situations arise where estate planning including IRAs can become complicated.

An example would be when the biological parent dies at a relatively early age, leaving an IRA to the surviving (non-biological parent) spouse. There could be a significant amount of time where the surviving spouse needs financial support – all the while the children could be denied access to their inheritance.  It’s not hard to imagine a scenario where there is an adversarial relationship between the children and the surviving spouse, with concerns arising over the surviving spouse’s management of and use or distribution of the funds in the inherited IRA.

Structuring IRAs for Blended Families

Of course, estate planning requires much more than simply reviewing the IRA components of your collective assets.  It is necessary to review all retirement accounts, life insurance policies, trusts, transfer-on-death accounts (TOD) and property titled as joint tenancy with rights of survivorship – all of the assets that are not normally impacted by testamentary trusts or wills.  These assets will pass directly to the named beneficiaries and/or surviving owners.  In addition, reviewing the tenets of your will and/or testamentary trusts will round out the picture.  By doing such a review, you can tally up all of the assets that are being directed to each heir under current conditions.

Given this starting point, you’ll want to consider how you want to distribute your assets compared with how they are presently to be distributed.  Often in such cases, it may be discovered that there is an inequity to the assets initially inherited by the spouse, with the children as secondary, or remainder, beneficiaries.  In a blended family this can cause animosity between the children and the surviving non-biological parent. (Imagine a “death watch” by children with regard to the step-parent.)  Steps can be taken to ensure that the children receive an inheritance separate and apart from the remainder sums that (for example) would be available from an IRA or a retirement plan.

The reason this is necessary is that, if an IRA (or other qualified plan) is the primary asset in the estate, upon inheritance by the surviving spouse there is no guarantee that the IRA will have any assets at all upon the death of the second spouse – or even if the original secondary beneficiaries will continue to have that status.  Since the surviving spouse has the ability to treat the inherited IRA as his or her own account, he or she can designate other beneficiaries (perhaps his or her own children?), thereby cutting out the original owner’s children.  But it doesn’t have to be that diabolical… it could be that the surviving spouse remarries and decides to use the entirety of the IRA in purchasing a yacht to sail around the world with her new husband.  In either case, your original intent may not be carried out by a simple designation of beneficiaries and contingent beneficiaries.

To achieve an appropriate division of assets among the surviving non-biological parent and the children, several options are available.  For example, life insurance policies could be used to provide an equitable inheritance to the children immediately upon your death.  Another option would be to split the IRA into separate IRA accounts, naming each of your intended heirs individually on the separate accounts to ensure that each child (and the surviving spouse) receives whatever you deem to be that individual’s appropriate portion of your estate.

Another item of importance is that if some of your assets are in a qualified retirement plan such as a 401(k), you need to take extra steps – especially if you intend to leave those assets to someone other than your spouse.  Since accounts like a 401(k) (e.g., 403(b) or 457 plan) are under the jurisdiction of ERISA (and IRAs are not), the regulations require that if you name someone other than your spouse as the beneficiary of the account, your spouse must waive his or her rights to the plan assets.  By rolling over those assets to an IRA, you will have much more flexibility in designating beneficiaries of the assets.  (It should be noted though, that when rolling over funds from an ERISA-controlled plan to an IRA with a non-spouse beneficiary, your spouse will still have to sign off, waiving rights to the account.)

The Point

The point of all this is that, too often the decision of naming beneficiaries of your IRA or other qualified plan is perceived as an “automatic” choice – spouse as the primary, children as the secondary beneficiaries.  In a blended family there are complications of relationships that you need to address and account for in your plan.  If you don’t pay careful attention to what this really means in terms of actual distribution of assets among your beneficiaries, the result can be something much different from what you hoped for.  This can be especially troublesome in a blended family of the sort described previously.  By making some changes with your IRAs or accounting for asset distribution with life insurance policies (for example), you can ensure that your assets are distributed in the fashion that you’d hoped for.

Note: I have purposely not included discussion of estate taxes in this article in order to relieve complexity – specifically in light of the “limbo” that estate taxes are in as of this writing in May, 2010.

Photo by Steve Snodgrass

Problems With Naming a Minor Your IRA Beneficiary

Apr 15th, 2010
by jblankenship.
7 comments

cherries by Dudley CarrWe’ve discussed the fantastic benefits that can be realized over time by naming a very young person as the beneficiary of your IRA (see “How To Turn $5,000 A Year Into a $33 Million Legacy” for details).  This makes for a very elegant, clean tax-planning exercise; but in reality, a minor cannot legally hold assets such as retirement accounts.  It’s a standard legal principle that individuals are not allowed to take title to assets until they are of legal majority, which is generally 18 or 21 years of age.

So what’s a budding legacy-builder to do?

A Trusted Alternative

Without a doubt the simplest way to resolve this is to name a trust as the beneficiary of the IRA, and then name the minor beneficiary of the trust.  The trust can receive the IRA and the trustee ensure that the RMDs are properly distributed.

Once distributed, since the beneficiary is a minor, the trustee has to figure out what to do with the money.  One answer to that question is to place the funds in a minor trust – a standard form of which is known as a Uniform Transfers to Minors Act (UTMA) trust.  The same trustee (or a different one, if you wish) can be the trustee of the UTMA account, making sure that the funds placed there are invested wisely on behalf of the minor.

Then when the minor reaches majority age (18 or 21, depends upon the state), the account can be transferred to the control of the original beneficiary of the IRA.  The same can be done with the trust receiving the IRA as beneficiary – the trust can terminate and the (former minor) beneficiary can continue receiving RMDs from the IRA over his lifetime.

A Key – Timing of These Arrangements

It’s vitally important to wring out all of these details prior to the death of the original IRA owner – since the beneficiary designation can’t be changed after she passes away.  If a trust isn’t set up to receive the inheritance on behalf of the minor, it’s quite possible that the resolution would be for the courts to appoint a guardian over the account on the minor’s behalf.  This could be one of the minor’s parents – but then again it might not.

Regardless, this guardianship would introduce a great deal of complexity to the situation, as the court would no doubt want control and oversight into the investment and distribution activities on the account.  Talk about time consuming, expensing, and intrusive!  What a mess.

By taking the time to straighten out these details in advance, you can rest assured that your heirs will be able to enjoy the fruits of your labors for many years to come – without a lot of stress and headaches.

Parting Comments

It should be noted that in the case of a smaller IRA – say, less than $50,000 – it would be cost prohibitive to establish and maintain a trust.  In such a case, the beneficiary designation could be to a custodian for the benefit of the minor under the UTMA rules until the beneficiary reaches the age of majority.  It’s important to make sure that you name successor custodians in such cases, since it’s possible that the original custodian may not be available to act as custodian.

Another factor to keep in mind is that you should address these matters on behalf of ALL beneficiaries for the account – primary and successor – who are minors.  Remember that the reason you name a successor beneficiary is because of the possibility that the primary beneficiary might predecease you.  With that thought in mind, make the same arrangements for your successor beneficiaries as you would for your primary beneficiaries.

Photo by Dudley Carr

IRAs Do Not Pass Through Your Will

Mar 4th, 2010
by jblankenship.
1 comment

gates of paradise by ConsciousVisionHere’s a little fact that you may not realize:  when you assign a beneficiary for your IRA account, you are effectively bypassing any outside action against that account – assuming that the beneficiary assigned is appropriate.

For most assets that you own, when you pass away, your last will and testament determines who will receive the assets.  You may want to make sure that your daughter gets the heirloom china set, and you son receives the antique car, among other things – so you direct these wishes through your will.

If you don’t have a will, the state, through the probate process, will determine how your assets are to be distributed.  Generally this is to your living heirs in order from your surviving spouse to your children and then grandchildren; but it’s different in each state, so it really makes a lot of sense to set up even a simple will to make sure everything goes to the people you want it to.

But your IRA doesn’t go through the direction of your will or the probate process, as long as you’ve properly assigned a beneficiary or a group of beneficiaries.  The great thing about this is that, since the assignment is generally cut-and-dried (i.e., beneficiaries are named specifically, so there are no questions), your heirs can immediately access the funds in the IRA account if the need should arise.  See the article here to find out more about proper choices for beneficiaries of an IRA.

Photo by ConsciousVision

Choosing a Beneficiary for Your IRA

Feb 26th, 2010
by jblankenship.
4 comments

peoples choice award logo by ponchosquealOne of the very important tenets of estate planning is to ensure that you’ve made an appropriate choice, or set of choices, for beneficiary(s) of your IRA account(s).  The title of this article could be a bit misleading – the point of this article is to list some of the consequences of various choices for a beneficiary of your IRA.

Don’t get me wrong – this article doesn’t suggest that the tax consequences should drive your choice of beneficiary(s).  Rather, the assumption here is that you have several beneficiaries to choose from, and other classes of assets that you can direct toward heirs that aren’t as able as others to take advantage of the tax-favorable provisions.

Following are the benefits and consequences of some of the major groupings of choices that you might make for beneficiary(s) of your IRA.

Age

Younger Individual

If you choose a young individual as the beneficiary of your IRA, your heir will be able to take advantage of long-term tax deferral using the method that provides for payout over the life expectancy of the beneficiary.  By doing so, the tax-deferred status of the account can remain in force for a considerably long time (consider a 2-year-old heir, providing for 80+ years of potential tax deferral).

Older Individual

If you choose an older individual as the beneficiary of your IRA, this heir can also take advantage of the life expectancy payout method – but the payout period will be much less (due to the age of the beneficiary).  Therefore the tax-deferral benefit will be considerably less for the older individual versus the younger individual.

Spouse (any age)

Directly

If you leave your IRA directly to your spouse by name, he or she can elect to treat the inherited IRA as his or her own IRA.  This means that your spouse will be able to defer distributions from the account until he or she reaches age 70½, and then use the Uniform Life Table for distributions.  As you know, the ULT is much more favorable than the Single Lifetime Table, which is the one required to be used by owners of inherited IRAs.  Your spouse can also name his or her own beneficiary for any amounts remaining in the IRA at his or her death – which provides for additional deferral in the account.

In Trust

If instead, you decide to leave your IRA to your spouse via a trust (even a look-through trust), you remove the possibility for your spouse to assume ownership of the trust (as described above).  By doing so, the account must be treated as an inherited IRA, subject to the immediate Required Minimum Distributions from the account, regardless of the age of your spouse.  Further deferral of taxes is limited in many cases, since if the spouse is younger than 70½ he or she has to take distributions now rather than delaying until age 70½.  In addition, your spouse will be required to use the less-favorable Single Lifetime Table for the distributions; your spouse also cannot name his or her own beneficiary for the account for further deferral after his or her death.

Now, if the spouse is the sole beneficiary of the trust, the account can be treated as if it were directly inherited by your spouse, as in effect the look-through trust becomes a conduit trust.  With a conduit trust, the effect is the same as naming your spouse the sole beneficiary of the account – so the same rules apply as when you leave the account directly to your spouse.  The only difference is that you’ve spent extra money drafting the trust agreement.

Other Beneficiary Options

Group (versus Individual)

Leaving your IRA to a group of people instead of one person, this can introduce quite a bit of complexity to the situation.  Where possible you could split your IRA into separate accounts and direct each account to an individual beneficiary, saving your beneficiaries a lot of extra headaches at your passing.  If this is not possible or you would prefer not to split your account your heirs can do it later – it’s just a lot of extra paperwork for them that you could have handled for them in advance.  See this article for additional information on splitting inherited IRAs.

Charity

As tax-exempt entities, charities do not have to pay tax on any donations.  So if you choose to name a charity as beneficiary of your IRA, there are no tax consequences on an asset that would otherwise be fully subject to ordinary income tax.  This can be a very tax efficient way to provide charitable bequests – leaving your more tax-favorable assets to non-charity recipients.

Your Estate

If you choose to leave your IRA assets to your estate – either intentionally by naming your estate as beneficiary, or unintentionally by not naming a beneficiary or by naming a non-look-through trust as your beneficiary – tax deferral benefits are lost. Estates and non-look-through trusts have no life expectancy, therefore there is no life expectancy payout option.  This is not to say that there are no good reasons to choose your estate as beneficiary of your IRA – but that’s a topic for another post…

Bottom Line

As I mentioned before, you should not cause the tax code to be the determining factor when choosing a beneficiary.  You should leave your assets to whomever you wish.  You can, however, use the information on this page to help guide your process of choosing a beneficiary, making tax-efficient choices.  Making thoughtful decisions about this process can ease the tax burden for your heirs.

Photo by ponchosquealº

Understanding the 2010 Estate Tax Repeal

Feb 15th, 2010
by jblankenship.
3 comments

The start of a new year often signals a time for change–especially when it comes to taxes, and 2010 has brought some major changes. As of January 1, the federal estate and generation-skipping transfer (GST) taxes are repealed, and the step-up in basis rule is modified for 2010. While it’s possible (and some believe very likely) that Congress will reinstate these taxes, until that time, it’s important to understand these significant federal tax law changes and how they might affect you.

Federal estate tax repeal

In 2009, the top estate tax rate was 45%, and estates received an exclusion of $3.5 million, (meaning that up to $3.5 million of assets were exempt from estate tax). However, as part of the tax cuts initiated in 2001, the estate tax is repealed for 2010 but is scheduled to return in 2011, albeit with a reduced $1 million exclusion and an increased top tax rate of 55%.

It’s possible Congress may reinstate the estate tax retroactively, that is, back to January 1, 2010, in which case heirs who already received their inheritance may have to reimburse the estate to enable it to pay the reinstituted estate tax. On the other hand, heirs who haven’t received their inheritance may have to wait for their gifts until the likely challenges to the constitutionality of instituting the estate tax retroactively have been resolved in the courts. In any case, until these issues have been cleared up, it may be wise for executors and trustees of estates in 2010 to retain sufficient assets in the estate to pay a potential estate tax.

What should you be doing about the estate tax? Review and, if necessary, revise your estate planning documents, like wills and trusts. For example, many wills and trusts drafted with an estate tax in mind leave an amount of assets up to the applicable exclusion amount to children, with the balance going to the surviving spouse. However, in 2010, since there is no estate tax, there also is no exclusion. Depending on how documents are worded, this could create a situation where all of the assets pass to the children with nothing going to the surviving spouse, or vice versa. Thus, it’s important that your estate planning documents be reviewed to ensure that your intentions are actually carried out.

Generation-skipping transfer tax repeal

The generation-skipping transfer tax is a federal tax on transfers of property made, either during life or at death, to an individual who is more than one generation below you, such as your grandchild. The tax, also repealed for 2010, had a $3.5 million exemption in 2009 and a top tax rate of 45%. However, like the estate tax, the GST tax is also scheduled to be reintroduced in 2011, with a $1 million exemption and top tax rate of 55%.

What should you do about the GST tax in 2010? The repeal of the generation-skipping transfer tax in 2010 means the elimination (albeit temporarily) of one of the taxes on gifts made during life. The other applicable tax is the gift tax, which provides a $1 million lifetime exemption and a top tax rate of 35% in 2010. The gift tax rate is scheduled to increase in 2011 to 45%. Thus, assets can be gifted in 2010, either directly or through a trust, to grandchildren and younger generations while accounting only for the gift tax, unless, of course, the GST tax is reinstated, retroactively or otherwise.

Step-up in basis repeal

Along with the 2010 repeal of the estate tax and GST tax is the partial elimination of the step-up in basis rule. In 2009, the tax basis of property in a decedent’s estate was generally increased, or stepped up, to the asset’s fair market value as of the decedent’s date of death. However, in 2010, the cost basis of estate assets is equal to the lesser of the decedent’s adjusted cost basis or the fair market value of the assets on the date of the decedent’s death. This means that estate assets likely will retain the decedent’s cost basis. Absent Congressional action to the contrary, the modification of the step-up in basis rule is temporary, with the full step-up in basis rule scheduled to return in 2011.

The law does allow estates to exempt up to $1.3 million of gain (generally, the difference between the decedent’s cost basis in property and its date-of-death fair market value), which executors and trustees may allocate among estate assets. Also, an additional $3 million of gain may be exempted for assets passing to a surviving spouse. This means that estates in 2010 may be able to increase the cost basis of assets up to $4.3 million.

The modification of step-up in basis can lead to some issues for estate administrators. For example, executors or trustees of estates larger than $1.3 million will have to figure out which assets should receive the step-up in basis. This is especially important for heirs and beneficiaries other than a surviving spouse.

In addition, heirs who want to sell inherited assets not covered by the step-up in basis will have to try to figure out the decedent’s cost basis in order to calculate potential capital gain. For example, assume you inherit shares of XYZ Company stock in 2010. You sell them and now have to determine whether you owe a capital gains tax. First, you need to know if any of the $1.3 million step-up in basis applies to these shares. If your XYZ stock didn’t receive a basis step-up, you’ll have to figure out the cost basis of your inherited stock. Arriving at the cost basis of inherited property may prove difficult, if not impossible, especially if the decedent didn’t keep accurate purchase records, or if the stock split over the years, or if the decedent received some of the stock by gift or inheritance.

What’s next?

Most observers believe Congress will restore these taxes retroactively sometime in 2010. There are a number of proposals under consideration and exactly what plan will be adopted and when are important questions that remain unanswered.

Another potential issue surrounds the constitutionality of Congress reinstating the estate tax and/or GST tax retroactive to January 1, 2010. Congress has imposed taxes retroactively in the past and when challenged, taxpayers have lost the majority of the time. Whether Congressional reinstatement retroactive to January 1 will withstand a challenge is conjecture at this point since Congress has yet to act, but the possibility of reinstatement of either or both taxes further adds to the estate planning conundrum in 2010.

One case that is likely to receive a lot of attention deals with the estate of author J. D. Salinger, who recently passed away.  Salinger, author of the classic book The Catcher in the Rye, died in 2010 with the film rights to his book unspoken for – as Salinger repeatedly denied offers from a multitude of Hollywood luminaries to turn the book into a blockbuster.  Those rights, plus the purportedly written and unpublished works Salinger left behind, could be worth a huge fortune to his heirs.  And with the current limbo of estate tax laws, this situation is likely to become a defining test case for the ages.  As Salinger’s character Holden Caulfield stated “… money.  It always ends up making you as blue as hell.”

And don’t forget to consider possible state taxes. Currently, 16 states plus the District of Columbia impose their own estate and/or inheritance tax, separate from any federal estate tax.

Despite all of this uncertainty, do not put off making or reviewing your estate plan. Not having an estate plan, or having an outdated plan, could mean your intentions aren’t carried out and could cost your surviving spouse and heirs.

The table below summarizes the evolution of the estate, generation-skipping transfer, and gift taxes over the three years affected, barring any changes by Congress:

Year Estate tax Generation-skipping transfer tax Step-up in basis Gift tax
2009 $3.5 million exemption

45% top tax
rate

 $3.5 million exemption

45% top tax
rate

 Full step-up
in basis		 $1 million
lifetime
exemption

45% top tax
rate
2010 Repealed Repealed First $1.3
million gets
step-up

Assets to
spouse get
added $3
million
step-up

 $1 million
lifetime
exemption

35% top tax
rate
2011 $1 million exemption

55% top tax
rate

 $1 million exemption

55% top tax rate

 Full step-up in basis $1 million
lifetime exemption

45% top tax
rate

 
Copyright 2010 Forefield Inc.

The Dreaded “Double Tax” on IRAs

Jan 17th, 2010
by jblankenship.
1 comment

double delight by audreyjm529Chances are, if you hold a significant amount of money in your IRA accounts, you may have been approached by a financial professional who tells you about the “double tax” that may be a part of your account’s future.  Here’s a brief explanation:  when the owner of an IRA dies, assuming that the size of the estate is greater than the exclusion amount (which is a dicey question in 2010’s “limbo” for estate taxes – see below for the 2010 and 2011 specific explanations), your estate will have to pay tax on any amount above the exclusion.  Presumably this includes your IRA account… and THEN, when your heirs begin taking their Required Minimum Distributions from the IRA account, they will have to pay ordinary income tax on the amounts that are distributed.  Hence the term double tax.

It’s a real situation that could happen – you should be aware of it, if you happen to be in that position… and you should also be wary of any financial professional who claims that you can avoid the double tax by taking your money out of the IRA.  Typically this pitch is designed to sell you an immediate annuity or some other form of annuity product.  The problem is, pulling the money out of the IRA does nothing to eliminate the double tax.

In fact, what this does is to accelerate the process and cause you to pay one part (the ordinary income tax) on the distribution up front.  Plus, this is usually pitched as a lump sum maneuver, which increases your taxable income and thereby increases the rate at which your distribution is taxed.  Clearly, if someone tells you that pulling all your money out of your IRA will avoid the double tax situation, you should walk away and don’t look back.

Instead, if this double tax is a concern for you – that is, if your estate is large enough to be impacted by this – it makes good sense to review the entire potential estate and consider planning out your distributions to your heirs.  A gifting plan, along with appropriate trust mechanisms, can possibly reduce your gross estate below the exclusion level.  This could have the effect of eliminating any double taxation issues in advance, and is truly the only way to possibly avoid the dreaded double tax.

2010-Specific Situation

As the law is presently in force, there is no estate tax for 2010.  Because of this, the double tax situation doesn’t apply.  At the death of an IRA owner, the IRA begins distributing to the heirs as required (see this article for more information), but no estate tax is owed on any part of the estate.  The “step-up” or basis carryover provisions do not apply to IRAs, other than the basis referring to any part of the IRA assets that were attributable to after-tax, non-deducted contributions or rollovers.

It’s possible that the law may be changed soon, and possibly changed retroactive to the first of the year, so stay tuned…

2011 and beyond

As the law is presently written, beginning in 2011 the estate tax exclusion is $1 million, and step-up of basis is back in force.  Again, if the funds are in an IRA, there is no step-up, although as noted before, basis of after-tax contributions and rollovers remains intact.

So if your estate has the opportunity to be greater than $1 million in value, any amounts above that exclusion amount will be subject to estate tax.  If those assets that are above the exclusion amount include your IRA, then your heirs will also have to pay ordinary income tax on the distributions – effectively paying tax again on the same money, the double tax.

As you can see, with the 2011 law, it doesn’t take long to have an estate that is possibly impacted by this double taxation situation, so it would likely make sense to review your overall estate plan and determine if there is a way to avoid the tax on some part of your estate.

Photo by audreyjm529