We've seen all kinds of publicity of late applauding the demise of the 15% excise tax on "excess" retirement plan distributions and "excess" accumulations held in a retirement plan at death. The tax was a "success tax" and good riddance to it.
What isn't as well understood is that people who die owning retirement accounts and annuities will still have those assets taxed twice - once for federal estate (and sometimes state death) taxes that can claim up to 60% of their value, and again for "income in respect of a decedent" - or "IRD" - income tax in the hands of the recipient. IRD attacks nearly half the estates big enough to file estate tax returns.
Consider Happy Harry who dies with a $10 million estate, which includes a $1 million IRA rollover. If Harry named his son Kiddo as his sole heir and his IRA beneficiary, the IRA alone will trigger a federal estate tax of $550,000. But Kiddo won't net $450,000. Because of an onerous and quirky income tax calculation, he'll wind up with just $209,520!
But let's suppose Harry was a generous guy who really didn't mind leaving $1 million of his $10 million to his favorite charity. If Harry left stock or real estate to charity, Kiddo will benefit from a $1 million estate-tax charitable deduction reducing the taxable value of his father's estate, but he still must pay $550,000 in estate tax and $240,480 in income tax on the IRA.
If Harry was both generous and well advised, Kiddo can really make out. Had Harry left appreciated stock or real estate to Kiddo and the IRA to charity, look at the result. The estate gets the same $1 million estate-tax charitable write-off - but incurs no IRD on the IRA. After all, charities are tax-exempt. So, Kiddo saves $240,480 in income tax.
What's more, he'll never be taxed on the stock's or real estate's appreciation to the date of Harry's death. His basis gets "stepped up" - so, when he sells his inheritance, much of his capital gain will be income-tax free.
Charitable gifts of retirement assets and other IRD items often make good planning sense. But this area of the tax law is fraught with peril, and the careful coordination of one's estate and retirement planning is essential to insure the intended result.
The Lane Report is a publication of The Law Offices of Marc J. Lane, a Professional Corporation. We attempt to highlight and discuss areas of general interest that may result in planning opportunities. Nothing contained in The Lane Report should be construed as legal advice or a legal opinion. Consultation with a professional is recommended before implementing any of the ideas discussed herein. Copyright, 2003 by The Law Offices of Marc J. Lane, A Professional Corporation. Reproduction, in whole or in part, is forbidden without prior written permission.