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Proper
planning during life can reduce or eliminate federal or state estate
taxes or state inheritance tax to the benefit of your heirs. Many
important income tax considerations come into play in “planning
for the inevitable.” You need to understand how various income
tax attributes are affected at death, steps you can take during
life to use those tax attributes that would be lost at death, the
factors involved in transferring tax attributes to your estate or
beneficiaries where you have such choices, and how to otherwise
make sound decisions regarding special rules that arise when a person
dies.
In many cases, your executor or other personal representative will
be in a position, after appropriate consultation with us or another
professional advisor, to take actions that will save taxes on your
final income tax return or save income taxes for your estate or
beneficiaries. But, in other cases, the personal representative
will be locked into choices you make during life and won't have
the latitude to take actions that will save the most taxes for you,
your estate or your beneficiaries. Therefore, it is imperative that
you have at least a basic understanding of the various choices and
the kinds of planning you can take during life to optimize savings
for all parties involved. Here are the more widely applicable topics
to consider:
Choice of executor. The primary duties of your
executor or other personal representative will be to collect your
assets, pay your creditors, and distribute the remaining assets
to your heirs or other beneficiaries. The executor also will have
to file various types of tax returns and make important choices
on them. Therefore, it is imperative that you choose someone who
is both trustworthy and competent to serve as your executor or personal
representative.
Income in respect of a decedent (IRD). Income that
was due to a person but wasn't paid before his or her death will
be taxed to his or her estate or beneficiaries. With proper planning,
charitable-minded clients can wipe out the income tax bite on IRD.
Partners and S shareholders. Clients in this category
need to know how they will be taxed on their share of the entity's
income in the year of death and how their successors will be taxed.
Tax-favored medical accounts. An individual who
has a health saving account, Archer medical savings account, or
Medicare advantage medical savings account is in a position to choose
whether the account's assets will be taxed in his final return or
to a named beneficiary or will escape tax if he is married and names
his spouse as beneficiary.
Holders of Series E or EE savings bonds. Choices
can be made before and after death to minimize taxes on the interest
on these bonds.
Compensatory options. Individuals who have received
compensatory options, statutory or nonstatutory, face various issues
with respect to transferring them at death and the ultimate tax
consequences to beneficiaries who receive the options. For example,
incentive stock options are accorded favorable tax treatment but
this treatment is lost for disqualifying dispositions of the stock
acquired on the option exercise. A transfer at death isn't a disqualifying
disposition even though it might have been if made while alive.
IRAs and retirement plans. Owners of individual
retirement accounts (IRAs) and participants in company-sponsored
qualified retirement plans need to understand how their benefits
will be taxed at and after death. For example, IRA distributions
from an inherited traditional IRA are taxable to the beneficiary
in the year received as IRD up to the IRA-owner-decedent's taxable
IRA balance at death. If the estate is large enough, the IRA funds
also will be subject to estate tax but the recipient of the IRA
distributions will get a special income tax deduction for the estate
tax attributable to the IRA.
Deductions. A host of issues come into play with
deductions at death. For example, unused net operating losses carryovers
and capital loss carryovers expire if not used on an individual's
final return—they can't be used on the estate's income tax
return. Certain deductions may be allowed to recipients of IRD.
Unpaid medical bills at death are subject to a special deduction
choice for an executor. This is just a sampling of the many different
income tax rules that affect an individual at death. With proper
planning during life, you can help to reduce taxes for the benefit
of your heirs. You can also arm your executor with the key information
he will need to make the best choices for them.
Please contact us if you would like to learn more about any of these
items or other items that could impact your estate and your heirs.
To comply with the requirements of IRS Circular 230, we must inform
you that the information discussed above is not intended or written
to be used, and cannot be used by the recipient or any other taxpayer,
for the purpose of avoiding penalties that may be imposed under
the Internal Revenue Code or any other applicable tax law, or to
promote, market or recommend to another party any transaction, entity,
investment plan, arrangement or other matter.
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