Ask the Experts: Inheritance Taxes a Complex Matter
May 23, 2011 (The Sacramento Bee, Calif.) How to handle taxes on inheritances and monetary gifts are this week's "Ask the Experts" questions. The advice is from IRS tax expert Jesse Weller.
QUESTION: I am the trustee of our family's living trust. The principal beneficiaries are three grandchildren. My father passed away and my stepmother is in very poor medical shape. When the distribution is made to the grandchildren, what are the state and federal tax liabilities and how can I best minimize them? The estate's gross value is about $1.5 million.
ANSWER: Federal tax rules regarding trusts are affected by several factors, such as the type of trust and its specific provisions.
Generally, income earned by a trust is taxable to the trust, unless it is distributed to the beneficiary. If income is distributed to beneficiaries, it normally is taxable to them.
The general rule is that income earned by a trust during the tax year is reported on Form 1041, U.S. Income Tax Return for Estates and Trusts. If income is distributed to a beneficiary during the year, it would be reported on Form 1041 Schedule K-1.
The best source to ask about protecting trust assets and minimizing taxes is an estate planning attorney, certified public accountant or enrolled agent.
Q: My brother passed away a year ago and left a life insurance policy worth $100,000. His wife was named as beneficiary. Before he died, he told her he wanted me to have the $100,000. They did not, however, change the beneficiary name. His wife wants to honor her husband's wishes. If she gives me the life insurance money, will I have to pay income taxes?
A: If your sister-in-law makes a gift of the life insurance proceeds, you would not pay federal income taxes on the gift. A gift ordinarily is nontaxable to the recipient, regardless of how large.
If your sister-in-law - or any taxpayer - gives another person gifts that total more than $13,000 in 2011, he or she is required to file a Form 709, U.S. Gift Tax Return. Even if a gift tax applies, it may be eliminated by the "unified credit," which applies to both the gift tax and the estate tax. The unified credit against taxable gifts in 2011 exempts up to $5 million from tax.
Any unified credit used against the gift tax in a given year reduces the amount that can be used in a later year. The total amount used in a person's lifetime reduces the unified credit available to use against estate tax.
Before making the gift, it may be worthwhile for her to consult with an estate planning attorney or tax professional.