Tax Considerations in Structuring Inheritances
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When dividing assets in an estate plan, the testator might be inclined to evenly split assets for heirs. However, if not planned for properly, federal and state tax requirements nevertheless could result in an uneven split of assets upon distribution. When deciding how to structure asset transfers, asset owners should consider the pre-tax and after-tax values. Different tax rules apply to retirement accounts, collectibles (art, classic cars, memorabilia, and other collections), investments, annuities, real property, and other assets in one’s estate.
Another factor to consider: Each heir faces a unique tax situation, with requirements for income reporting based on an individual’s gross taxable income for the year. Income from inherited assets that are distributed to one heir could be taxed significantly differently for another. If the asset owner fails to consider this and plan appropriately, they could set up an heir to inherit tax liability. Also, consider where the heir resides. North Carolina passed a bill in 2013 that protects inherited Individual Retirement Accounts (IRAs) from state bankruptcy claims, but assets could be compromised if heirs reside in other jurisdictions.
Trusts are some of the best tools for minimizing tax liability. Review options with an estate planning attorney to learn about ways to customize the trust so that Trustees have flexibility in timing distributions to beneficiaries. Postponing or timing trust distributions could help to ensure that beneficiaries have access to trust assets while at the same time giving them the flexibility and discretion to retain the assets in trust. Spendthrift provisions can also be included, which can prevent a beneficiary with questionable spending habits from wasting assets and accruing tax debt as a result.
Structuring inheritances based on after-tax values with respect to each heir’s projected tax situation can help to prevent unequal distribution between children and other family members. Unequal distribution of one’s estate could fuel family conflicts in addition to creating an otherwise avoidable tax burden for heirs in higher tax brackets. If it is the testator’s intention to disproportionately distribute assets to family members, the testator should consider informing heirs during the testator’s lifetime as well as referencing his or her intent in a will or trust document to further clarify and prevent heirs from contesting the will.
Aside from judiciously reviewing and dividing assets for heirs, testators should consider another unfavorable inheritance for surviving family: Debt. Our Chapel Hill estate planning attorneys review more about debt inheritance here and how debts at the time of death are handled by the estate.
By Attorney Samantha Reichle
