Estate Tax | robergtaxsolutions.com

Photo by Matt Lowden on Flickr.com

Good question. I bet you’re looking for a yes or no answer though and it’s not quite that easy.

Everybody talks about the “death tax” but for most people, there’s no such thing. Generally, if you inherit money, you do not pay tax on it. There are a couple of states that tax inheritances, but the federal government does not.

But… (You were waiting for the ‘but’ weren’t you?) While you won’t be taxed on the inheritance itself, you can be taxed on the income of a deceased person’s estate. The easiest way to explain this is with an example.

Let’s say your Uncle Bob dies and leaves you $10,000 in his will. Cool. You get $10,000 cash, and that’s it. There’s no inheritance tax. He just left you a dollar amount; nothing to it but cash.

But what if instead of just leaving you cash, your Uncle Bob left you half of his estate? Suppose he leaves half of everything he owns to you and the other half to your sister. Let’s say he has $50,000 cash in the bank.

It might take some time for the estate to settle and for you and your sister to get what’s coming to you. During the time after your uncle’s death and before you settled the estate, the estate (that is, the stuff your uncle used to own) made some money. Interest was paid on the bank account. While you won’t pay tax on the $25,000 cash you get, you will pay tax on the interest that the cash earned while it was part of the estate. It will be “passed through” to you as the beneficiary.

That’s the part that’s really confusing to most people. You read the IRS books that say inherited money isn’t taxable—it isn’t. But the income that money earns while it’s sitting in the estate is.

The taxable income will be reported on a document called a K1. If you’ve never seen one before, it’s a little intimidating. But if you’re doing your own taxes, you just input the numbers from the K1 into the boxes in the software and you’re going to be okay.

So, if the $50,000 in the bank earned $1,000 in interest and you’re supposed to get half of the estate, then you’ll pay tax on $500 (your share of the interest earned) and you’ll get $25,500. (Half of the $50,000 plus half of the interest earned.)

Now, realize that I’ve really simplified this. Usually there’s more than just a bank account. There will be stocks, a house, maybe even a business. But the idea is basically the same: you pay tax on the income that the estate earns, but you don’t pay tax on the value of the actual stuff in the estate. (If we’re looking at estates that are worth over $5 million dollars, referred to as the $5 million estate-tax exemption—that’s another story, but that’s not what I’m talking about today.)

Photo by Blaise Machin

I don’t often get requests for what to post in my blog, but I was actually asked to write this one.

You can leave all of your money to your dog when you die. Now I don’t recommend it, but it’s possible. Maybe you heard about Leona Helmsley, the wealthy hotel maven who left her money to her dog in her will. Yes it’s true. And, it’s actually more common than you might expect.

But is leaving your money to your dog the right thing for you? Probably not, and here’s why. First, a dog doesn’t have a social security number. (I’m reading this back to myself and it sounds like an episode of Mr Roger’s Neighborhood; “Dogs don’t have social security numbers!” But it’s true.) Without a social security number, dogs can’t file a regular tax return. And you’re not getting a social security number for your dog– so don’t even try to go there.

If you want to leave your money to your dog, you have to set up a trust. My dog’s name is Lady so if I wanted to set up a trust for her I’d probably call it the “Lady Browser Inheritance Trust.” Two points about naming the trust: first, it should properly identify the trust. If you just call it “dog trust” there could be dozens of other dog trusts out there and there could be some confusion. It will have an identification number, of course, but a unique name is helpful to the people who will be working on it after you’re gone. Second: don’t give it a terribly stupid name. Remember that someone is going to have to manage your trust after you’re dead. You might have no problem calling your dog “Kitchikookoo-picky-poo-poo” but the person managing the estate might.

You will fund the trust by making it the beneficiary of your estate. For example: Let’s say that you name the trust, “Duke Dog Trust.” Then, you would make “Duke Dog Trust” the beneficiary of your bank and financial accounts. If you’re really serious about doing this, you need to think which accounts should go to your dog versus which accounts go elsewhere. You also need to think through who your secondary beneficiary will be should your dog die before you do.

Setting up the trust and funding it isn’t all that hard. Really you just have the legal expense of setting up the trust. What’s more difficult is figuring out the care program for your dog. Anyone who’s serious about leaving their estate to their dog is really more concerned that their pet is well cared for than anything else. You’ll have to include specific care instructions outlining feeding, grooming, exercise, veterinary care, etc. and who is going to be responsible for that care and how it’s paid for.

Once again, that brings me back to my original observation—you probably don’t want to leave your money to your dog. Why? The taxes! Dogs can’t really inherit money, everything goes into the trust. Trusts are usually set up as “pass through” entities. Usually a trust is set up so that people get money from it. For example: Grandparents setting up a trust for a grandchild. The money in the trust earns interest, the interest is “passed through” to the grandchild and the grandchild pays taxes on the interest at his income tax rate. (10, 15, 25, 28 or 33 percent) Income in a trust is taxed at 35%. You don’t get a deduction for the expense of caring for the dog. About the only deduction you get is paying your attorney and accountant fees, the rest is all taxable. Leaving your money to humans is much more tax effective. First, if you have less than $5 million dollars, your heirs can inherit the money tax free. And your estate can be settled within about year. Income from your estate can be passed through to your heirs at their personal income tax rate instead of the estate tax rate. People you love will get more of your money instead of it going to lawyers, accountants, and taxes. Leaving money to a trust for a dog is the worst possible tax strategy for your estate. Now if it’s the only option available to you, then so be it. But if you can arrange to have your pet cared for after your death and leave your money to a human, that’s that best situation from a tax standpoint.

Category: Estate Tax

Is My Inheritance Taxable?

Leaving Your Estate to Your Dog