I realize that the standard answer in questions related to trusts is to see a lawyer. I also realize a standard answer is to say that it varies by state.
I am wondering if anyone knows a quick and definitive answer to the following.
In this case, the state is Florida. My Dad is convinced that as long as he keeps the money total under “X dollars” in a revocable living trust, then my sister and I will not owe any taxes on that money when he dies and it passes on to us.
That sounds like bullshit, so I am checking here to see if anyone knows for sure and can hopefully back it up with a cite or reference.
First, beneficiaries of an estate generally don’t pay taxes. The estate pays the tax, i.e., whatever tax is owed is deducted from the estate before any distribution is made to beneficiaries. A significant exception to this rule is “income in respect of a decedent (IRD)”. Generally, this takes the form of funds that were in an IRA, a 401(k), or other qualified retirement plan that was funded with pretax dollars. In this case the beneficiary does pay income tax on those funds when they are received, regardless of the amount of the estate or whether any estate tax was owed. Since these retirement plans are funded with dollars that never had any income tax paid on it, the income tax is due from the beneficiaries.
Second, the $5 million exemption PastTense refers to applies to the total estate, not what is in the revocable living trust. There may be pension plans, insurance policies, real estate, etc. that have not been transferred to the trust.
So, yes, as long as your father’s taxable estate (trust assets plus any assets not held in trust) is under $5 million, there won’t be any estate tax due. And the only tax you and your sister will owe as beneficiaries will be on income in respect of a decedent.
A lot of people are under the misconception that trusts have secret sauce which exempt them from estate taxes. That’s not really true. What trusts save is the time and expense of the probate process; the assets in the trust are transferred to the named beneficiaries immediately, according to the terms of the trust. But the assets of the trust are still considered part of the estate for tax purposes.
Wouldn’t money from the trust (to the children) be considered inome?
Again, the magic sauce discussion… sooner or later, money results in taxes. The $5M exemption basically says that the money you already earned and already paid taxes on, why tax it a second time?
Once you get over $5M, really, does it hurt so bad to actually pay some taxes?
No - it’s an inheritance. Except as I indicated above, proceeds received by inheritance, or life insurance, etc. are not considered income and are not subject to income tax.
Correct. Inherited money is very rarely considered income for income tax purposes. The exceptions have been described above.
If the estate is subject to estate tax (the $5M limit listed above), then that tax is payed by the executor of the estate prior to there being any inheritance at all.
That part at least makes sense. You earn money, you pay taxes on it, and you put it in a bank account. (or buy a house, or gold bars, et…)
When you die, someone else gets the money - if you took the money out of your savings account and bought a Maserati, you would not pay taxes all over again. Why should your heir?
I guess the point is that transferring from A to B due to death and inheritance does not create income the way B working for A does - it’s not an exchange, it’s not even really a gift in the sense of being deliberate and a choice.
(Of course, if you buy stocks with your savings, then at some point you or your heirs sell them and generate a profit (we hope). Taxes have to be paid on that capital gains. As I understand, it simplifies things to consider the transfer of stock a “sale” and settle the transfer and gains at one time.
What I don’t get is the rust. Effectively, as I understand it, I am giving this separate legal entity a wad of cash that others (depending on conditions, like me being dead) are free to withdraw. I fail to see how that differs from a gift or an estate.
And if the OP’s father is married, that exemption amount can be effectively doubled by the use of a credit shelter trust. It may be that that’s what the OP’s father is talking about.
Nowadays you don’t even need a credit shelter trust (although it can help). In 2012, the $5 mil exemption became portable, so that any unused exemption from the first spouse to die gets transferred to the surviving spouse.
For an irrevocable trust, you might actually be able to use one to avoid or minimize estate tax. You have gift tax issues to look at as assets are put into the trust, but the general idea is that if you gift in $1 million today and it grows to $10 million by the time you die, you’ve avoided estate tax on $9 million.
The catch is that most people don’t understand the difference and they conflate everything they’ve heard about trusts all into one giant mess.
An irrevocable trust doesn’t give you the step up because the assets are gifted before death and become assets of the trust.
For people with $10 million to move around, this strategy makes sense. Capital gains are a lot lower than the estate tax. But then you get people who think the same thing is good for their $1 million estate who just end up costing everyone money and headaches.
And even then, when the heir sells the stock, s/he uses the value of the stock at the time of inheritance to figure out the gain they’d be taxed on. I’m not sure what happens if they sell sooner rather than later, though – if it gets taxed at the short term or the long term rate (assuming the decedent hadn’t just purchased the stock).
ETA: Sorry, labdad, glazed over your response there.
The holding period for inherited property is always long-term. So even if the deceased bought it the day before his death and the inheritor sold it the day after his death, it would be a long term capital gain/loss.
By the way, it’s not the value at the time of inheritance, but rather the value on the date of death, unless the executor of the estate exercises the option to use the alternate valuation date.
Let me also clarify that we are talking about US law here. Certainly the rules are different in other countries.