Death and Taxes: The Basics

Dear Liza: My cousin passed away in 2011, and she had a revocable living trust. My cousins inherited the assets 50/50. The assets were stocks. Do my cousins have to file income tax returns for what they received? Also, am I required to file an income tax return for the trust? Your cousins inherited the stocks at their value on the date your cousin died in 2011. Inheritances are NOT ordinary income under the federal tax code, so they receive those assets free of federal income tax. (We have a federal estate tax; if any tax was due, it would have been on your deceased cousin’s estate, if she owned more than $ 5 million in assets when she died.)  Seven states have an inheritance tax, so they’ll need to check on whether any state inheritance tax is due.  Your two cousins will be responsible for filing income taxes on any dividends they received after inheriting the stocks, and for any capital gains earned when they sell that stock if it has appreciated since they inherited it. You, as Trustee, would be responsible for filing a trust income tax return (Form 1041) if the trust earned more than $600 worth of income between the time your cousin died and the time the trust assets were distributed to the beneficiaries.

Estate v. Trusts, what’s the difference?

Dear Liza: What distinguishes an Estate from a Trust? A person’s estate is all of their property owned at death.  If they have a Will, that document states who inherits the estate.  If they die without a Will, state law determine who will inherit their estate.   In both cases, if they have enough assets, a probate court has to supervise the settling of the estate.  A trust is a legal agreement in which a person (called a Grantor) states that one or more people (called Trustees) hold the Grantor’s assets for certain people (called the beneficiaries) subject to certain duties and the terms of the agreement.  The most common type of trust is called a revocable living trust, but there are others.  A person may set up a living  trust to hold certain of their assets (like their house) during their lifetime, and then give those assets to others at their death. Assets held in the living trust do not go through probate, which is why most people set them up.

But, that person almost certainly owns other assets in their own name (like their everyday checking account, their car, and their tangible personal property). Those things are part of that person’s estate, not their trust.  They would ordinarily have a special kind of Will (called a pour-over Will) that says that all of these things should be added to their trust upon their death. That way, there’s just one set of instructions about who gets what.

I Inherited a House, Now What?

Dear Liza: My 90 yr. old mother recently died and I inherited her home, her only significant asset.  I  am preparing the Affidavit-Death of Trustee.  Does this put the title to the house in my name or do I also need a Quitclaim deed?  Do I need to create a new trust of my own or can it be left in the current one as I am a co-trustee? Sorry to hear about your Mom.  You are now engaging in what’s called “Trust Administration.”  The Affidavit Death of Trustee says that you are now the successor Trustee of your mother’s trust. (That means you have the legal authority to act under the trust with respect to the real property.) The next step for you is to then record a Trustee’s Deed transferring the property from that trust to yourself as an individual. (That gets the house to you outright and free of her trust.) If you want to set up a living trust, do that.  Then you’ll transfer the house from your own name to yourself, as Trustee of the new trust by recording a Trust Transfer Deed.  You can’t just leave the house in your mother’s trust, because now that she’s died, that trust is irrevocable and can’t be amended or changed.  Also, as Trustee, you’re just the manager of the assets, not the owner. You can use Nolo’s resources to create your own trust or work with an estate planner, that’s up to you.

Should I add my son to the title of my house?

Dear Liza: I thought about putting my son on the title of my house so he would have additional financial support. I’m not just real comfortable with that idea. I know creditors can and do go after people with ownership to a home.My son is doing well, but he does have a large student loan he needs to repay. What do you think about my adding him to the title of my house?  I think you should listen to that inner voice that isn’t comfortable with the idea.  You are absolutely right that adding him to the title puts your assets at risk to his creditors.   Also, if you put him on title, you are making a taxable gift to him of one-half the value of the house and you should report that on a gift tax return by April 15th of the following year. (You won’t owe any gift tax, most likely, because at the moment you can give up to $5.12 million without having to pay gift tax, but you still have to report any gift over $13,000.)  Finally, he will get your one-half of the house with a capital gains tax basis of what you paid for that house (and I’m guessing it’s appreciated since then.)  If he ever does sell it, he’ll owe capital gains taxes on the amount it’s appreciated since you purchased it.  You can leave him the house at your death, if that’s what you want to do, but for now, I wouldn’t recommend it.

What to Expect From Your Attorney

Dear Liza, I live in Wisconsin and met with an attorney on November 16, 2011, to discuss updating existing wills and powers of attorney for healthcare and property for my husband and myself.   It has been over three months since we met, and while I am ignorant of the ins and outs of the legal process, this seems an excessive amount of time to wait with no word.  How long is a reasonable period to wait for a draft of my will, and how should I approach my concerns with her? I am so sorry to hear that you’re having this sort of trouble. I think that you should discuss your concerns with her directly. Call her up. Ask her to call you back to discuss this. Tell her that you don’t want yet another email. Tell her that you need to see drafts within two weeks. Remember that YOU are the client and your attorney needs to be responsive to your concerns. If you aren’t happy with her, get a new lawyer.  You are completely within your rights to hire someone who is more responsive and to ask your first attorney to forward your client file to your new lawyer. As for what’s reasonable…well, it’s not that I haven’t occasionally been swamped myself, but I think two to three weeks from the initial consulation is a reasonable time to expect to see an initial draft, or at least to be contacted by your attorney with an apology for being late on the drafts. Good luck.

Amending a Living Trust

Dear Liza:  My mom and dad set up a revocable living trust and now dad has passed away. Can my mom amend it?  My answer is: Maybe. If your parents set up a trust that’s pretty common for married couples, in which the trust is divided into two trusts after the first spouse dies, your mother can’t amend the trust that holds your father’s assets.  She can, however, amend the trust that holds her assets, which is revocable during her lifetime.  This is called an A/B Trust.  To find out if your parents have that kind of trust, find the section that says what happens after the first spouse dies. If it says to divide the assets into a ‘Bypass Trust” and a “Survivor’s Trust” or a “Credit Trust” and a “Marital Trust,” then your parents established an A/B trust.  However, if that section says something like the assets are to be held in a revocable trust for the survivor’s benefit, then your mom can amend the entire trust (because it was never divided into two trusts).

Selecting Professional Executors

Hello Liza, My husband and I need to update our wills, they are terribly out of date.  Our dilemma is around the question of who should be Executor/Co-Executor of the estate. Obviously we would be the executors of one an others estates, however, if something were to happen to both of us, we need a third party Executor/Co-Executor.  We have no obvious relatives, or even close friends that we feel could ask to be an Executor.   We’ve understand that a law firm, bank, financial planner, etc.can act as an Executor (or co-Executor).  Our question is, what is the financial obligation for doing so?  Trust companies, trust departments of banks, and individuals, called professional fiduciaries, can serve as the executor of your estate.  There’s no up front fee for nominating an institution or professional to serve in that capacity. They would charge the estate a fee for their services if they are appointed to serve after the death of the second of you.  Often, these fees are a percentage of the estate. If your estate goes through probate, your executor is awarded statutory fees based on state law, which are usually a percentage of the value of the estate.  Attorneys sometimes serve in this capacity, but, at least in the state where I practice (California) there are strict rules about doing so, because in the past unscrupulous lawyers wrote themselves into client’s documents to generate future fees. Financial advisors often cannot serve due to conflict of interest rules in their companies, but some can.  I would advise you to ask your local bank or financial advisor what their fees would be for this service, or if they can recommend anyone in your area who could serve.

Trusts and Pour Over Wills

Dear Liza,  My husband and I are having a disagreement about how to set up our living trust. (We are using online trust software.) He says that our will designates how to disperse the trust, after both of us die and the two designated trustees who are in charge of the trust will need to follow the will’s direction and that the trust is merely a holder of property and we don’t “need” to add all the beneficiaries to the trust document, that the will suffices. I say that we need to designate all the beneficiaries in the trust itself and clarify that all the property in the trust, unless specifically designated otherwise, will be inherited equally by our six children and that the will is for designating who gets the red pot or the carpet, etc., that sort of thing. Who’s right? So, one of the really nice things about being an estate planning attorney is that I hardly ever have to weigh in on marital disputes. On this one, though, I’m on your side. As a general rule, a living trust is designed to hold your property that would otherwise be subject to a probate proceeding at the death of the second of you–usually your house and your large brokerage and bank accounts. The assets in that trust pass by the terms of the trust itself. The ‘Trustees can’t follow the instructions in the Will, they have to follow what the trust says.

 The Will, in this scenario, is designed to transfer any assets that you owned at death that weren’t in the trust into the trust at that point. That’s why this Will is often called a ‘pour-over’ Will– like the saucer under a teacup, it picks up the property you’ve left outside of the trust and pours it into the trust (the cup) after your death. Often, too, your tangible personal property (jewelry, furniture, red pot, clothes, etc) are distributed under the terms of the Will, but sometimes these assets also pass into the trust to be distributed there.  So, make the trust the document that contains your wishes for the distribution of your estate, and let the Will just do the cleanup job for you.

Lifetime Gifts

Dear Liza: My friend has a stock portfolio she wants to give me before she dies.  She had cancer and only has a few months to live.  She wants to give it to me now to avoid the whole estate thing.  The total is about $220,000.  Do I have to pay gift tax if she transfers the portfolio to me in kind?  I am sorry to hear that your friend is so ill.  She can give you that portfolio, but it might not be the most tax-effective way to do it.  If she gives you the portfolio before she dies, she (or her estate) must report the gift on a gift tax return by April 15th of the following year. She won’t owe any gift tax on the transfer, because in 2012, each of us can give up to $5.12 million dollars free of gift tax, but any gift over the annual gift tax exclusion amount of $13,000 must be reported on that gift tax return.  If you later sell any of that portfolio, though, you will owe capital gains taxes on the difference between your friend’s basis in that stock and the sales price.   For example, if your friend owned stock in Y Corp., that she purchased for $1 dollar a share in 1982, and that stock is worth $100/share in 2013, you will owe capital gains on that $99/share rise in value.  Alternatively, if she gives you that portfolio upon her death, you will inherit it at the current fair market value for capital gains tax purposes.  In other words, if that Y Corp. stock is worth $100/share when your friend dies, and you later sell it at that price, you will owe zero in capital  gains taxes.  That portfolio will, however, be part of her taxable estate at her death, so, depending upon her other assets, her estate may or may not have to pay estate tax on those assets.  (Currently, she can give up to $5.12 million at death free of estate tax.) So, you and your friend should seek the advice of an accountant to see whether it makes sense for your friend to give you that stock via a Will or a trust upon her death, or during her lifetime.

Using Disclaimers in Estate Planning

Dear Liza: I am the executor of my aunt’s estate in NJ.   She left a number of payable-on-deaht (POD) accounts to me  but her intention was that most of these funds/accounts be given to charity.  I am trying to avoid paying estate and inheritance tax on them, because then the charities will get less.  Is there a way I can redirect them to the charities before they come to me so as to avoid the taxes? When someone gives you something in a Will, or by beneficiary  designation,you can always say, “No Thank You” and not accept the assets, provided you don’t make use of the asset first, and that you do this within 9 months of the death. This is called ‘disclaiming’ the assets. Legally, it’s as if you died first — the asset is then given to whomever is named as the next beneficiary.  In that case, the gift is from the person who died, not from you.  What you can’t do, however, is direct where the assets go next. So, if your aunt left a Will that said everything in her estate was to go to you, then to charity if you did not survive her, your disclaimer would direct those assets to the charity, via that Will. However, if your aunt’s Will did not specify charities as the next beneficiaries, or did not have a Will and simply left those payable-on-death accounts directly to you, and named no second beneficiary, the only way you can give those assets to charity would be to do it directly as a gift from you. If you disclaimed those assets, they would pass to your aunt’s surviving heirs under New Jersey’s law of intestate succession, not to charity. You can give $13,000 per year to any beneficiary free of the gift tax, or $26,000 if you are married and your spouse agrees to make the same gift.