Death Transfer Fees

In contrast to the federal estate tax which is the I.R.S. cut before the estate moves on to the heirs, and which most estates are small enough to escape, estates that earn more than $600 in a year face an income tax. The period during which an estate may be liable for the income tax is from the date of death of the decedent until the estate is distributed. Many estates never earn $600 in a year. For example, the estate could consist of a house that is never rented and never earns income. Or it could consist of bank accounts that at today's low interest rates don't pay interest equal to $600 a year or more. If the estate earns more than $600/yr. there are two options. First, the estate can pay the income tax by filing a 1041. If there are many heirs, this may be the most efficient way to go for all concerned. Or, the estate can file the 1041 and a K-1 stating what portion of the income tax each heir is liable for and that the tax liability passes on to the heirs. If there is only one or two heirs this may be the most efficient way to go. This is a question to be discussed with a tax accountant.

Suppose someone dies in April of 2014. The personal representative of the estate will have to determine if the decedent filed a 2013 tax, if not, the personal representative will have to get one filed. If the decedent had enough income to be subject to income tax in the part of 2014 that he lived, then a Decedent's tax return from 2014 will also have to be filed. Depending on the complexity of the return and the ability of the personal representative, either the personal representative can do that or they can hire a tax accountant.

Money in a traditional IRA (not a Roth IRA) is earned income that has escaped being taxed at the time it was earned. Also, interest, dividends, and capital gains earned within the IRA escape taxation until the money is taken out of the IRA. In a sense money in a traditional IRA comes with a built in tax lien. If a person takes this money out during their lifetime, they pay tax on the withdrawals as if the withdrawals were regular income. If a person dies with money in a traditional IRA and the IRA is paid out upon the person's death, tax is due on the IRA money as if though it were earned income.

Typically, IRAs are set up with a primary and a secondary beneficiary. These beneficiaries (the primary one if alive, otherwise the secondary beneficiary) may be able to roll over the IRA money of the dead person into their own IRA and thereby avoid immediately paying taxes on the IRA money. However, if a trust is the beneficiary of the IRA the tax on the IRA money may become due at distribution to the trust. On the other hand, there can be valid reasons for making the trust either the primary or secondary beneficiary. These include:

1. If a minor is the beneficiary, a trust allows for control of the minor's money past the minor turning 18 and many clients desire this.
2. If the primary and secondary beneficiaries die before the owner of the traditional IRA, the money in the traditional IRA will have to be probated at some expense and time delay.

In addition, the tax benefits of being able to roll over an IRA may or may not exist. The beneficiary may need the money immediately in which case there is no roll over. But, also, when the IRA money comes out it is taxed as ordinary income (unless there is an additional penalty for early withdrawal). The potentially lower tax rates on dividend and capital gain income is lost for a traditional IRA.

In conclusion, whether to put a traditional IRA into a trust is a very complicated matter that depends in part upon future events that cannot be predicted.