Accounting Income Taxes in Your Estate Plan

The estate planning process is complex. It involves more than just deciding which heirs or beneficiaries will receive a person’s assets. Testators will need to grapple with complicated tax-related issues when planning their estates, including how to save their loved one’s from paying excessive income and transfer taxes upon inheritance. While this was often more challenging in prior years when both the estate and gift tax exemption were lower, doing so is still not a simple endeavor. If you are concerned about the tax repercussions of some of your bequests, please reach out to Alan G. Orlowsky today for help.

The Income Tax Basis of Inherited Assets

One step testators can take to save their heirs trouble at tax season is to make plans for gifts that use the annual gift tax exclusion. When individuals make transfers using this exclusion, those transferred assets will be removed from their estate and will retain the income tax basis of the donor. On the other hand, assets inherited upon the death of a testator receive a new “stepped-up” tax basis, which is equal to the fair market value of the asset on the date of the testator’s death. For instance, an asset costs $100, but had a fair market value of $1,000 – the tax basis of that asset would be $100, if it was given as a gift during a testator’s lifetime. However, the gift was received via inheritance, its tax basis would be $1,000.

Because the gift tax excludes any post-transfer appreciation generated by an asset, testators can still potentially reduce their estate tax liability by transferring assets during their lifetimes. In this way – even when a testator’s gifts exceed the annual exclusion amount, the testator will only be required to pay the gift tax based on the asset’s current value and not on its appreciated value down the road.

Converting Traditional Retirement Accounts

When a beneficiary inherits a traditional 401(k) or IRA account, he/she also inherits the income tax liability that goes with it. This means heirs are required to pay regular income tax on distributions from these types of retirement accounts until the accounts are liquidated, which in turn must be completed within 10 years of the original account holder’s death. When account balances are large, this could require significant distributions, which would also be taxed at a higher rate. Fortunately, it is possible to avoid leaving beneficiaries with a tax bill by converting traditional accounts to Roth accounts, which have tax-free distributions.

Do You Need Help Creating or Updating Your Estate Plan?

If you need help setting up an estate plan or have questions about the tax-related repercussions of some of your own bequests or the bequests of a loved one, contact Orlowsky & Wilson, Ltd. Attorneys at Law at 847-325-5559 to speak with one of our experienced Chicagoland estate planning lawyers about your concerns.



Updated as of July 2019
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