By Tim Barkley. September 2016.
Estate planning is often discussed in the context of the “typical American family” – Mom, Dad and 1.8 happily adjusted children. But what if that’s not you?
Planning for unmarried, divorced or widowed clients who have no children presents a special challenge to the planning professional, and requires ingenuity and resourcefulness to avoid the traps for the unwary.
The parents of the “typical American family” leave their assets to their children without a thought about the Maryland Inheritance Tax. Most folks don’t even know that it exists. That tax is a flat 10% tax on distributions to anyone except lineal ancestors (parents and grandparents), lineal descendants (including stepchildren) and their spouses, and siblings.
Prominently missing from the list of recipients not subject to the tax is nieces and nephews. Yet many of this writer’s elderly single clients have no one else to leave their estate to. Everyone else is dead.
The inheritance tax rate, while relatively low compared to other tax rates, creates a large tax bill in absolute numbers. For example, if your estate consists in a house worth $300,000 and an IRA worth $300,000, the inheritance tax due is $60,000.
Not only is the inheritance tax a significant cost, but it increases other costs as well. Because the Register of Wills is receiving 10% of the value of the estate, that office is much more likely to scrutinize the valuation of assets and demand scrupulous adherence to appraisal requirements, increasing administrative costs. Often, liability for the inheritance tax eliminates the simplified “modified administration” option for estate administration.
While the inheritance tax cannot be eliminated (except by adopting your nieces and nephews), it can be avoided or minimized. Distributions to charity are not subject to the inheritance tax, so any large charitable donations you have intended to make can be made after your death and minimize the tax.
Gifts made more than two years before the date of your death are also not subject to the inheritance tax. If you have always intended to give your niece your car, an earlier gift is better than a later one, all other things being equal.
Jointly held property is subject to the inheritance tax, but only on the deceased person’s pro rata share. This means that if you added your niece and nephew to your bank account as joint owners, only 1/3 of the account would be subject to the inheritance tax, regardless of the source of the assets in the account.
There might be other reasons not to create a joint tenancy with your niece and nephew, but the tax consequences could be beneficial.
Inheritance tax due on property passing in trust to persons subject to the inheritance tax can be paid at your death based on the actuarial value of the interests of the beneficiaries, or can be paid when property is distributed. There can be good reason to proceed one way or the other; consult your estate planner.
If the property passing to the individual subject to inheritance tax is farmland or woodland, or National Historic Register property, the valuation of the property can be significantly reduced for inheritance tax purposes. That provides a planning opportunity if you want to leave your estate to your sibling and his son, with whom you have farmed for 30 years. The inheritance tax would be reduced if the farm were distributed to your nephew and other, non-agricultural property were distributed to your sibling, rather than vice versa.
If you have the opportunity, a distribution to your sibling with the understanding that he or she will distribute to his or her children upon his or her death would be tax-free, provided everyone cooperates and no one goes into a nursing home. Then the asset that was supposed to go to your nephew is diminished or eliminated by the costs of care.
Plan carefully, and even if the tax cannot be eliminated, it can often be reduced significantly.
Next article: Home Alone II, practical steps to help your surviving loved ones.
Attorney Tim Barkley
The Tim Barkley Law Offices
One Park Avenue
P.O. Box 1136
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