It’s been said that while tax evasion is illegal, tax avoidance is our responsibility as citizens. As an executor, you have a duty to do the best possible job for the estate’s beneficiaries. It’s also a fair bet that the will writer wants their assets to go to their loved ones — not the government. To accomplish this objective, you need a working understanding of what tax-saving opportunities exist (we can help), or to hire someone who has that expertise. The tax code provides opportunities to minimize taxes legally as your loved ones age and ultimately die. Your grasp of possible tax-saving options can minimize the tax liability for aging seniors and also for those who will inherit their assets in the will.
I always appreciate the opportunity to write about this topic, as I was given great advice on this subject when my father died in 2004. As executor, one of the first logical steps seemed to be to close his individual retirement account, or IRA. Fortunately, my sister Michele worked for a major financial institution and told me about a way to continue to allow that money to grow tax-free for decades — with something called an IRA-beneficiary-distribution account, or IRA-BDA. The result of that one piece of advice is that the $16,000 account now has a value of more than $40,000. And I continue to get a distribution of about $1,000 per year.
At Executor.org, we work to help those who are responsible for settling estates, including managing a person’s final financial matters. When possible, this planning is best started while the will writer is alive. Here we will share some effective strategies for this scenario, as well as an important strategy if your loved one has already passed. Since many of us will serve as executors for our parent’s estate after their death, starting a conversation about estate planning and money management with parents as early as possible will maximize your effectiveness in minimizing taxes.
3 Reasons to Plan a Funeral in Advance
Here are some proven strategies to pursue if the will writer is still alive:
1. Sell stocks with losses.
An individual may be able to take an income tax deduction for stock losses if they are alive. This means if they bought a share of stock for $300 and it is currently worth only $100, they can likely pay less in taxes by deducting the stock loss. Upon death, however, what was originally paid for a stock is no longer relevant — and losses are no longer deductible.
This is due to the “stepped-up basis” rule, which states that the value of the asset, for tax purposes, will be the value of the asset on the date of their death, not the original purchase value. So if that $300 stock is worth only $100 upon the owner’s death, the $200 loss can no longer be deducted. There is an exception whereby an executor can choose to set the “basis” (value) of the asset at six months after the owner died, rather than the date of the death, but this exception is typically only relevant with large estates subject to estate taxes. Keep in mind that there is a limit on losses that can be taken in a given year — and income tax losses carried forward do not extend beyond death.
2. Keep stocks with gains.
If an individual owns stocks that have increased in value since purchase, the “stepped-up basis rule” can greatly reduce their taxes when they die. The rule states that a stock owned by a deceased person is valued for tax purpose at it’s worth on the day they died. The purchase price is no longer relevant and not considered for tax purposes. For example, say your parent bought a share of stock for $100 several years before their death on the day they die, that same share is valued at $1,000. Using the stepped-up basis rule, there will be no income tax charged on the $900 gain if the stock is not sold until after their death.
3. Claim your parents as dependents.
This step will be a benefit to you, not your parents, but it is an effective strategy to minimize “family” taxes as your parents age. Dependents must meet certain criteria to be eligible, so it is not an option for everyone. The most important consideration is whether you provide more than 50 percent of the financial support for your parent. Social Security payments are included in this calculation. If a parent is living with you, you can take into account fair-market room rental, food, and other support costs in this calculation. IRS Publication 501 can provide more details on this if you think you may be eligible.
4. Give money to potential beneficiaries in a large estate.
Currently, estates above $5.45 million are taxed at a top rate of 40 percent. If your parents are fortunate enough to have an estate large enough to be subject to the estate tax, giving money to beneficiaries while they are still living can help minimize the tax liability of the estate once they die. Just remember to check if limits apply to the amount of money that can be given as gifts without tax consequences. Currently, that amount is $14,000 per person for the 2015 and 2016 tax years, according to the IRS.
5. Put money into trusts.
If your parents have significant assets, setting up trusts can make life a lot easier for beneficiaries (and avoid those assets having to go through probate court). However, remember that trusts can be complex. There are annual filing requirements, including the filing of a tax return for each trust. Plus you’ll need to find and possibly pay a trustee to manage each trust and the investments within it. Some trusts also put complex requirements on how beneficiaries can spend the money. These types of requirements can add complexity for professionals managing the trust, so they should be carefully considered.
Whether the individual for whom you’ll be an executor is still alive or has already died, this final strategy can be highly effective:
6. Manage IRAs strategically to minimize taxes.
Understand the tax implications before draining assets from an IRA. IRAs can be closed before a person dies, with any taxes to be paid at that individual’s tax rate. After they die, you can take a lump-sum distribution. Or you can choose to let the IRA continue to grow with taxes deferred with the IRA-BDA investment instrument. For most families, this is a powerful tool. With an IRA-BDA, you will receive payments annually over your expected lifetime, with any undistributed amounts released to your estate at your death. You’ll want to manage your parent’s IRAs to be taxed at the lowest rates possible, so talking to a financial adviser can be wise. In the case of the IRA-BDA, the tax deferment is of great value in most cases because the money you would have paid in taxes can earn compounding interest for you for many years.
Effective tax planning can have a substantial impact on the value of an estate, the amount of money ultimately received by beneficiaries, and the ability to defer taxes on dollars received. Take the time to understand the options you have available to you to be as effective as possible in managing the financial issues that are part of the 100-plus steps in the executor role. And when you do, you can take comfort in the fact that you were a good steward and ensured that your parent’s money went to their choice of beneficiaries, not the government.
Have a question about executorship? Get an answer by sending an email to [email protected].
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Patrick O’Brien is CEO and co-founder of Executor.org, a free, comprehensive online resource that helps executors manage their responsibilities and duties in this complex role. The free tools include a helpful step-by-step interactive guide for executors and invaluable tips on everything from planning a funeral and keeping beneficiaries happy to dealing with grief and managing estate assets.
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