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Your Taxable Estate
The word "estate" has different meanings. Many people incorrectly assume that a person's "probate estate" (which is discussed in the previous article) is the same thing as a person's "taxable estate." All of a person's probate estate is included in his or her taxable estate. However, the taxable estate may also include other assets—such as jointly held property, assets held in trust, or assets payable to a designated beneficiary—that were not part of the person's probate estate. This article will explore what is included in a deceased person's estate for federal estate tax purposes. The analysis of the estate for tax purposes is important because that will determine if a federal estate tax return (the return, Form 706, is 44 pages long) needs to be prepared and filed. It also is the starting point for determining if any tax will be payable. Finally, certain assets that are included in the estate receive a new income tax cost basis even if no federal estate tax return is required to be filed. That income tax cost basis is the value as of the deceased person's date of death.
If you were to make a chart of the taxable estate and the probate estate, their relationship might look something like this, depending on the what percentage of the taxable estate was comprised of the probate estate:
The starting point for determining what is included in the estate
for tax purposes is to assume that everything that the deceased person
owned is included. This can include all the assets that were included
in the probate estate, plus many others. For example, the taxable
estate includes real estate (including foreign real estate if the
deceased person is a U.S. citizen or resident), stocks, bonds
(including U.S. savings bonds and tax-free municipal bonds), mutual
funds, cash (in banks and credit unions, under the mattress and in the
safe deposit box), limited partnerships, ownership in the family
business, life insurance proceeds, jointly owned property, and
retirement benefits (pension plans, profit-sharing plans, individual
retirement accounts, and employee stock ownership plans). It also
includes amounts owed to the deceased person at the time of death such
as promissory notes, land contract receivables, uncashed checks, unpaid
wages and refunds such as insurance premiums and income tax. The
deceased person's personal property, such as household items, cars,
boats, collections, tools, and computers, is also included.
In some cases, the deceased person owned a fractional or percentage interest in an asset. For example, the deceased person owned a one-half interest in a piece of real estate without any rights of survivorship. In that case, only the one-half interest is included in the estate.
Jointly owned property (i.e., property owned by the deceased person and at least one other person with rights of survivorship) has some unique rules. If the property is jointly owned by a husband and wife, only one-half the value of the property is included in the deceased spouse's estate. In all other cases, thefull value of the asset is included in the estate of the first joint owner to die except to the extent it can be proven that the remaining joint owners paid for a share of the asset.
Some assets are included even if the deceased person had no apparent ownership interest. For example, a surviving widower deeds his residence to his two adult children and continues to live in it until he dies. The Internal Revenue Service has been successful in maintaining that the deceased widower retained the right to live in the residence for life (called a "life estate"), either explicitly or implicitly. There is a provision in the estate tax law that says an asset is included in a deceased person's estate if he or she gives the asset away and retains certain rights. These retained rights include such things as the right to possess or enjoy the asset or the right to the income from the asset.
Setting up a trust and transferring assets to a trust doesn't necessarily remove the assets from your taxable estate, even though it will remove those assets from your probate estate. For example, if you set up a revocable trust (in which you can revoke or amend the trust) and you transfer all your assets to the trust, the assets will still be included in your taxable estate when you die because you retained the right to amend or revoke the trust.
On the other hand, if you set up a trust that you cannot amend or revoke and you transfer assets to the trust, those assets will not be included in your estate if you are not a trustee or a beneficiary of the trust.
Even if an estate does not have to go through probate because it is comprised entirely of "non-probate" assets (such as assets held by a trust), it still is important to identify and value all of the decedent's assets. Without doing so, there will be no sure way to determine whether the estate is liable for estate tax, nor will there be a sure way to determine that all beneficiaries have received their complete share of the estate assets.
This summary is intended as a source of general information. If you have questions or desire additional information, please contact Ryan M. Wilson at (517) 377-0897 or rwilson@fraserlawfirm.com.