Simple Estate Planning – Part 2

Simple Estate Planning – Part 1 discussed ways to reduce inheritance taxes and simplify estate planning through the use of bank accounts. Bank accounts are often a small part of our assets. Wealth is often held in the form of savings bonds, mutual funds and stocks.

Transfers of assets on death between non-spouses (excepting life insurance and certain retirement benefits) are subject to PA Transfer Inheritance Taxes at either 4-1/2%, 12%, or 15% depending on your relationship to the deceased asset holder. Transfers on death between spouses pass free of such tax.

The rules for joint bank accounts generally apply to other joint assets. If you hold savings bonds, mutual funds, or stocks jointly for more than 1 year before death, the portion subject to tax IN MOST CASES is based on the deceased owner’s share of the asset. This is often a good way to hold savings bonds which increase in value as they mature. For example, if a parent adds a child’s name to E or EE bonds, the bonds will belong to the surviving owner on the co-owner’s death. The surviving owner can delay redemption of the bonds to defer federal income tax on the interest until a bond matures. Savings bonds are subject to Inheritance taxes based on the date of death redemption value. One caveat about where you keep jointly titled savings bonds: If jointly titled bonds are kept in a safe deposit box owned by the person who dies first, and the co-owner on the bonds did not have access to the box, taxes are assessed on the full redemption value. The theory is that there was an incomplete gift from the deceased bond holder: the gift was not completed prior to death as evidenced by the co-owner’s lack of access to the bonds resulting in the inability to redeem them. Thus, it is not always wise to store jointly titled bonds in a safe deposit box.

You can also reduce inheritance taxes by placing mutual funds or stocks in joint names. If you hold a mutual fund or stocks jointly with another person, then on your death, the asset passes without the need for probate, and inheritance taxes are due on your share of the asset, providing the asset was titled jointly for more than 1 year and both parties had access to the asset. However, while you save on inheritance taxes, you may be subjecting the co-owner to unfavorable income tax treatment. When you transfer an asset to your name jointly with another person, the cost you purchased the asset for becomes the co-owner’s cost as well. If you acquire an asset at a low value and later place it in joint names, gain or loss on a sale will be determined by the sale price measured against your original cost for both owners. Stocks and mutual fund holdings generally (and hopefully!) appreciate over time and are held as long-term investments. If you buy securities or mutual funds which grow in value, then place them in joint names with another person, on your death the asset will pass free of probate and should be taxed on half the date of death value for inheritance taxes, but the co-owner’s gain on a sale is based on the price you bought the asset for. If you hold stocks or mutual funds in your own name, and they pass on your death to a non-co-owner beneficiary, while the inheritance taxes will be charged on the full date of death value, the new owner picks up the date of death value as the cost basis. This can be critical, because often after a death, there is a need to liquidate assets. For example, a share of stock purchased by you for $1.00 which increases in value to $1,000.00 could be sold after death without a non-co-owner beneficiary incurring much of a tax burden – the beneficiary’s “measuring stick” is the $1,000.00 date of death value. The same stock purchased for $1.00 but gifted via joint ownership will result in a larger tax burden for the co-owner who sells at the $1,000.00 price. Therefore, before you transfer these types of assets to joint names, the nature of the asset and its performance should be studied. The same caveat concerning savings bonds applies to storage of stock certificates: jointly titled stock certificates held in the safe deposit box of the first person to die are taxed at the full value if the surviving co-owner has no access to the certificates.

Bonds and mutual funds can sometimes be held in your name, “payable on death to” (“POD”) or “in trust for” someone else. This avoids probate, but the assets are subject to inheritance taxes on the full value. This type of ownership keeps the asset in your name, under your control during your lifetime, and for mutual funds, should allow for the “stepped-up basis.” “POD” bonds can be retained by the named beneficiary until he or she wishes to cash them in, thus deferring tax on interest. Stocks may not be able to be titled “in trust for.” Many companies will, however, permit solely owned securities to be transferred on death under certain circumstances without formal probate of an estate. If the only thing titled to a decedent is a small amount of stock, there is no reason to open an estate, and if the heirs are a spouse and/or children, it may be possible to transfer the stocks without formal probate. You owe full inheritance taxes, but could avoid large capital gains.

One final note that applies to all jointly titled assets – if the person who is added as a co-owner dies first, the original owner will owe inheritance tax on his or her own asset. If the joint ownership was created within a year of that person’s death, the entire value of the asset will be taxed under current Pennsylvania Inheritance Tax laws.

All angles should be considered when deciding how to title assets. The type of ownership for one asset may not be best for another. It is tempting to want to save inheritance taxes and title everything jointly. However, it may save on one tax, but result in a larger tax of a different sort. A review of your assets and holdings might be in order to determine what you own, how you own it, and what consequences may result from that ownership.