Estate and Gift Taxes and Choosing Beneficiaries (Houston Bar Association)
If your estate has a value that is less than the applicable estate tax exclusion amount at the time of your death, no estate taxes (sometimes also called, “death taxes”) will be due upon your death. Per the “American Taxpayer Relief Act of 2012” (“ATRA”), passed in January 2013, the applicable exclusion amount (or, exemption) for persons who die in 2013 or thereafter is $5,000,000, indexed for inflation, with inflation adjustments starting from a base year of 2011. Thus, for 2015, the estate tax exemption amount is $5,430,000.
In determining the size of your estate, all assets in which you own an interest (i.e., both probate and non-probate assets) must be taken into account and valued at fair market value.
The IRS has rules regarding what constitutes “fair market value” but, basically, it’s what an independent person would pay to buy the asset. Note that the IRS doesn’t care what method of transfer you use to transfer your assets to your beneficiaries when you die. Thus, even if you set up an estate plan to “avoid probate,” that does not avoid federal estate taxes.
Therefore, in addition to the assets passing under your Will (if any), your “estate” for federal estate tax purposes includes the proceeds of life insurance on your life passing to a beneficiary by beneficiary designation, assets held in your living trust (if any), assets held in “multi-party accounts” that pass directly to named beneficiaries, and qualified retirement plans, IRAs and annuities being distributed to designated beneficiaries upon your death. Since Texas is a community property state, only one-half of the community property is included in the estate of the first spouse to die. Of course, a deceased person’s separate property is also included in his/ her estate.
If you are married and your estate is larger than the exemption amount at the time of your death, you can defer estate taxes by leaving your estate either directly to or in a qualified Marital Trust for your spouse (special rules apply if your spouse is not a U.S. citizen). In that case, the estate tax will be deferred until your spouse dies due to the marital deduction.
However, the assets you give to your spouse (whether outright or in a Marital Trust), plus your spouse’s own assets, will be included in your spouse’s estate at the time of your spouse’s death (if not spent by your spouse during life) and could result in estate taxes becoming payable when your spouse dies.
The applicable transfer tax (estate or gift tax) is assessed against the person making the transfer (a decedent’s estate or the donor of a lifetime gift). No gift tax is actually due until the total of all lifetime gifts exceeds the applicable exclusion amount ($5,430,000 for 2015). A person making a taxable gift must timely file a gift tax return and pay any gift tax due. In some cases, the gift tax is apportioned to (charged against and recovered from) the recipient/beneficiary, but that is rare. The executor of a decedent’s estate must timely file the federal estate tax return (for estates over the applicable exemption amount) and pay the federal estate tax due, if any. Federal estate taxes are due nine months after the decedent’s death.
The only way to ensure that your IRAs are distributed to the beneficiaries you want is to put
your intentions in writing with your IRA custodian by completing a “beneficiary designation
form.” You may have named an IRA beneficiary many years ago when you opened your IRA
account. You should review this information periodically but, especially, when your personal
circumstances change. On the other hand, if you do not name a beneficiary, the default
provisions in your IRA Agreement will determine who will receive your IRA on your death. In
some cases, these assets could go to persons you don’t like, such as an estranged spouse.
IRA beneficiaries are described generally as being (i) a spouse, (ii) a non-spouse human being,
and (iii) a non-human being (e.g., an estate or charity). Your IRA beneficiary can be a person,
a trust or a charity. Each designation has particular pros and cons that you need to weigh
carefully in order to make sure your wishes are followed. You should also consider the tax effects
of your beneficiary designation.
Your surviving spouse can make a tax-free rollover of your IRA into an IRA rollover in his/her own name. If a spousal IRA rollover is made, (i) distributions from the account will be taxed at your spouse’s income tax rate when taken, (ii) required minimum distributions will not have to commence until your spouse reaches age 70½, and (iii) required minimum distributions will be calculated based on your spouse’s life expectancy, plus ten years. If your surviving spouse is “too young” to do an immediate rollover of your IRA (the penalty for early withdrawal will apply if your spouse rolls over your IRA to an IRA rollover in her name and takes any distributions prior to reaching age 59½), your spouse can remain in the position of being your IRA beneficiary, and take discretionary amounts without penalty before age 59½, and then start taking required minimum distributions from your IRA in the year when you would have reached age 70½, based on your spouse’s life expectancy, recalculated each year. Your spouse can do a spousal IRA rollover of your IRA at any time after your death, such as after your spouse reaches age 59½, when the penalty for early withdrawal no longer applies.
Leaving your IRA to your spouse may mean that your federal estate tax exemption amount (see Estate and Gift Tax section, above) is not being used and is, in essence, being “wasted.” The portability election can help avoid wasting the first spouse’s estate tax exemption amount in such a case, while preserving the favourable income tax treatment for the surviving spouse. If you have substantial assets, you should speak with an estate tax professional who can offer suggestions on how to reduce the total tax liability for your family. Another potentially negative consideration when leaving your IRA to your spouse is that your spouse then gets to control where “your” IRA ends up when your spouse dies. Thus, couples in second marriages have to consider this issue as well.