Wills, Trusts & Estates Prof Blog

Don't Leave Your Heirs an IRA Tax Bomb

Without proper planning, an inheritance from a traditional IRA can lead to significant taxes for beneficiaries, as their tax bracket determines the rate of taxation, not the original owner’s. Retirees often fall into lower tax brackets, while their children—typically working professionals—may fall into higher brackets. Additionally, under the IRS's 10-Year Rule, beneficiaries must withdraw the entire account within 10 years, potentially resulting in large annual taxable income.

One way to reduce this tax burden is by converting a traditional IRA to a Roth IRA. While taxes must be paid upfront during the conversion, withdrawals from a Roth IRA are tax-free for both the account owner and beneficiaries. Timing and strategy are crucial, as Roth conversions can impact Medicare premiums and Social Security taxes. Consulting a financial adviser can help determine the best approach for managing these variables and maximizing tax benefits.

Another strategy is to consider the tax brackets of your children when dividing assets. Allocating more funds from a traditional IRA to children in lower tax brackets and assigning less-taxed accounts, like money market funds, to those in higher brackets can help balance the tax impact. Though it may seem fair to split assets equally, post-tax outcomes can vary significantly among beneficiaries based on their respective income levels.

Additionally, retirees can prioritize withdrawing from their IRAs earlier in retirement. By doing so, they can reduce the account's taxable size, lowering the tax burden on heirs. This strategy not only helps beneficiaries but may also minimize the account owner’s taxes over time.

Finally, meeting with a financial adviser is crucial for those planning to leave an IRA to their children. Advisers can guide investments into other vehicles, such as CDs or annuities, that may be more tax-efficient while allowing the funds to continue growing. With proper planning and professional guidance, parents can ensure their inheritance is a financial benefit rather than a burden for their children.

For more information see Kelsey M. Simasko "Don't Leave Your Heirs an IRA Tax Bomb", Kiplinger Personal Finance, December 2024. 

Article: Integration of Taxes on Inheritances, Estates and Gifts into the OECD Model Tax Convention on Income and on Capital: The Curious Case of Special Provisions - Part 1

Jan Karol Szczepański (Independent) recently published, Integration of Taxes on Inheritances, Estates and Gifts into the OECD Model Tax Convention on Income and on Capital: The Curious Case of Special Provisions - Part 1, 2024. Provided below is an Abstract: 

Part 1 of this article considers the interaction between the special provisions in the OECD Model Tax Convention on Income and on Capital, and the conceptual foundations of taxes on inheritances, estates and gifts.

Managing an Inheritance: When 'Mom's Money' Becomes Yours

Millennials are set to inherit a substantial amount of wealth over the next two decades, as the silent generation and baby boomers transfer their assets. This shift, amounting to an estimated $90 trillion, could significantly impact millennials' financial futures. However, many millennials might not receive as much as they anticipate. A disconnect exists between millennials' expectations and the actual amounts boomers plan to leave, often due to high healthcare costs that diminish potential inheritances​.

The influx of wealth can create both opportunities and challenges for millennials. Financial advisers note that many young inheritors are unprepared to manage large sums of money, leading to potential stress and financial mismanagement. Guidelines for managing inheritances typically recommend spending a small portion on personal enjoyment, donating to charity, and prioritizing significant financial goals such as debt repayment or home purchases​​.

Despite the potential for increased wealth, millennials face unique economic pressures, including student debt and an inaccessible housing market. The financial confidence among this generation remains low, partly due to economic instability witnessed during their formative years. This cautious approach could either hinder their financial growth or safeguard against reckless spending, depending on individual perspectives and preparedness​.

For more information see "Managing an Inheritance: When 'Mom's Money' Becomes Yours", The New York Times, June 8, 2024. 

Special thanks to Joel C. Dobris (Professor of Law, UC Davis School of Law) for bringing this article to my attention.

How to Avoid Pitfalls When Loaning Money to a Family Member

Loaning money to family members is a generous but potentially risky move. To avoid common pitfalls, it’s crucial to formalize the arrangement with a written agreement detailing the loan amount, repayment schedule, and any interest charged. This not only sets clear expectations but also helps in case of disputes.

Charging a reasonable interest rate, even if it's minimal, can emphasize the seriousness of the loan and ensure compliance with IRS guidelines. It’s equally important to consider the impact on your own finances and be prepared for the possibility that the loan might not be repaid as planned. Always lend an amount you can afford to lose.

Clear communication is key. Discussing terms and expectations openly can prevent misunderstandings and preserve the relationship. Consulting with a financial advisor or lawyer can provide guidance on the legal and tax implications, ensuring the loan is structured correctly. By approaching family loans with the same diligence as any financial transaction, you can protect both your finances and your personal relationships.

For more information see Andrea Riquier "How to Avoid Pitfalls When Loaning Money to a Family Member," Barrons.com, June 11, 2024.

Special thanks to Joel C. Dobris (Professor of Law, UC Davis School of Law) for bringing this article to my attention.

Article: The Nation's Transfer Tax Regime and the Tax Gap

Jay A. Soled (Rutgers University) recently published, The Nation's Transfer Tax Regime and the Tax Gap, 2024. Provided below is an Abstract:

For over a century, the nation’s transfer tax regime, comprised of the gift, estate, and generation-skipping transfer taxes, has played a pivotal role in curbing inherited wealth while simultaneously raising much-needed revenue. But for a variety of reasons, a sizable number of taxpayers are derelict in fulfilling their transfer tax obligations. This analysis explores the reasons for this phenomenon and the reforms that Congress should consider instituting to curb this behavior.

Article: Donationes Mortis Causa of Real Property: Missed Opportunities and Foreclosed Possibilities

David Pittavino (University of New South Wales) and Xavier Walsh (Independent) recently published, Donationes Mortis Causa of Real Property: Missed Opportunities and Foreclosed Possibilities, 2024. Provided below is an Abstract:

The doctrine of donatio mortis causa defies and problematises the taxonomy of the common law. It stands both as an archaic monument to Western legal thought several millennia old, and as an informal, intimate, and human mode of disposition of property in the face of death. In New South Wales, there is stark resistance to extending the doctrine to gifts of real property. This article examines the justifications usually proffered for that resistance; critiques the strengths thereof; and argues that none, as a matter of doctrine, survives proper scrutiny. Part I of this article outlines three common objections raised against donationes mortis causa of realty, and contends that each fails fully to accord with fundamental tenets of the doctrine, in both its historical and contemporary contexts. Part II of this article explores the place for donatio mortis causa in the era of e-Conveyancing, and suggests that, in relation to Torrens Title land, any room left for the doctrine is now confined to circumstances where a donor transfers legal title to the property to the donee, revocation of which may give rise to an in personam exception to indefeasibility of title.

Article: Is the Inheritance and Gift Tax a Reasonable Alternative for the Net Wealth Tax?: A Legal and Economic Analysis Across OECD Countries

Anna-Maria Anderwald (University of Graz) and Rainer Niemann (University of Graz) recently published an Article, Is the Inheritance and Gift Tax a Reasonable Alternative for the Net Wealth Tax?: A Legal and Economic Analysis Across OECD Countries, Intertax Volume 50, Issue 6 & 7, 2023. Provided below is an abstract:

Net wealth taxes are one of the most controversial topics in taxation. Strained government finances due to the Covid-19 pandemic and the increasing inequality in the distribution of wealth are fuelling this debate (See, for example, Wealth Tax Commission, A Wealth Tax for the UK, Final Report (2020) that refers to the need to raise substantial revenue after the pandemic). While some countries (Especially France: The net wealth tax – referred to as the ISF (impôt sur la fortune) – was abolished in 2017. See also the overview in Rainer Niemann & Caren Sureth- Sloane, Investment timing effects of wealth taxes under uncertainty and irreversibility, Journal of Business Economics 89, 385 (2019), 405) have abolished net wealth taxes, their (re)introduction is being considered in others (For example, Austria, Germany, and the United States (proposed by Senators Elizabeth Warren and Bernie Sanders), to specify just a few of them). Unfortunately, legal and economic arguments are rarely brought together in the public discussion, and the academic tax community has remained relatively quiet. Given the politically delicate nature of net wealth taxes, an interdisciplinary discussion seems necessary.

This policy note focuses on the policy discussion on net wealth taxes from both economic and legal perspectives. It begins by identifying the characteristics of a net wealth tax compared to related taxes, such as property taxes and inheritance and gift taxes (Chapter I.). This is followed by an overview of the status quo of net wealth taxes and wealth-related taxes in the OECD (Organisation for Economic Cooperation and Development) countries (Chapter II.). Building on this, the article deals with the main arguments proposed in the literature in favour of and against the (re)introduction of net wealth taxes (Chapter III.). Since a net wealth tax has far-reaching effects on economic decision-making and on taxpayer compliance, a purely legal analysis is necessarily incomplete and requires an economic counterpart. Likewise, economically motivated tax reform proposals require an analysis of their legitimacy. A comprehensive discussion therefore requires a simultaneous legal and economic analysis.

Since net wealth taxes are predominantly justified with distributional reasons, this note also discusses whether an inheritance and gift tax represents a reasonable alternative to a net wealth tax (Chapter IV.). After all, an inheritance and gift tax could also counteract the inequality of wealth. The objective of this article is to provide an interdisciplinary basis for the tax policy debate on wealth-related taxes.

You Take a Friend on Your Yacht. Is It a Taxable Gift?

Supreme Court Justice Clarence Thomas has recently found himself in hot water over benefits received from his longtime friend, Dallas billionaire, and political donor Harlan Crow. The controversy has given rise to important questions about judicial ethics and disclosures, and begs the question, is generosity between friends taxable?

The U.S. gift tax was established in 1924 to prevent wealthy Americans from minimizing taxable estates by transferring assets to others before death. This year, the combined gift-and-estate-tax exemption is $12.92 million per individual or $25.84 million per married couple. 

However, there is a gift-tax exemption in addition to the lifetime exemption, allowing a person to make annual tax-free gifts to another individual. The 2023 limit is $17,000 per giver, per recipient, and as seen in Justice Thomas’ case, experts aim to answer when hosting a friend on an expensive vacation becomes taxable.

The answer is whether or not the giver is present. In the yacht scenario, if the giver of the boat cruise is present, the trip looks more like a party than a gift despite the fact that the price of hosting said guest exceeds $17,000.

For more information see Laura Saunders “You Take a Friend on Your Yacht. Is It a Taxable Gift?” The Wall Street Journal, May 19, 2023.

Special thanks to Joel C. Dobris (Professor of Law, UC Davis School of Law) for bringing this article to my attention.

ACTEC Shares Useful Resources

ACTEC 2022 Pocket Tax Tables  (helpful resource for professionals)

The ACTEC Pocket Tax Tables guide is a handy resource available for download as a pdf, online and mobile devices, and as a printed booklet. Content includes tables for Income Tax; Social Security; Estate and Gift Tax; Generation-Skipping Transfer Tax; Treasury Unisex Actuarial Table Examples; Inflation-Adjusted Numbers; Life Expectancy Tables; Qualified Plans, including SECURE Act details; Interest Rates; and Charitable Deduction.

ACTEC Trust and Estate Talk  (podcast series for professionals)

The Future of Digital Assets and the Dollar  Estate planning and family law attorneys share what to be aware of and some pitfalls when drafting premarital agreements and prenups.

Capital Letter No. 56: The Administration’s Fiscal Year 2023 Budget Proposals 

ACTEC Fellow Ronald D. Aucutt offers commentary regarding the Treasury Department's "General Explanations of the Administration's Fiscal Year 2023 Revenue Proposals" and how it provides a few new and a lot of previously presented ideas.

ACTEC Trust and Estate Talk  (podcast series for professionals)

California Tax Trap and Residency for Trusts - Words of caution for trust fiduciaries, beneficiaries and residents; CA has liberal definitions of who is considered a resident and subjected to tax on trusts.  

Taking the Sting Out of “Death Taxes”

Since September 2021, there has been a lot of talk about the Build Back Better Act, which included some major tax increases. However, it is most likely that the Build Back Better Act will not come to fruition. 

Although the Act is likely dead, the contents of the Act may be an indicator of what type of things Congress is likely to focus on in regard to taxes. An example of one of these areas are "death taxes." "Death tax" is a form of transfer tax and is formally refereed to as estate tax. 

There are three types of transfer taxes: 

1. The gift tax, which applies to gifts made during a life;
2. The estate tax, which imposes a tax on the gross estate prior to any bequests being made; and
3. The generation skipping transfer tax, which applies to gifts or bequests that are received by a person who is more than one generation removed from you (for example, a gift an individual makes to their grandchild).

 

Much of the conversation is surrounded around gift tax and estate tax. Congress sets a dollar cap "for gifts that a person can make during life or bequests after death before a transfer tax will apply. . ." This cap is referred to as the "exemption amount." A lot of the talk around the Build Back Better Act was focused on the potential change of this "exemption amount." 

Given the potential impact a change in the exemption amount can be, it is important to plan for the uncertainty. 

For more information: 

See Dylan H. Metzner, Taking the Sting Out of “Death Taxes”, Jones & Keller, April 1, 2022. 

Special thanks to Jim Hillhouse (Professional Legal Marketing (PLM, Inc.)) for bringing this article to my attention.