Updated: Jul 31, 2020
As we get older estate planning becomes more important as relatives and friends pass away. Our large tax and financial planning practice has encountered hundreds of calls from clients who need planning or to inform us that a loved one has passed away. Now some advice on how to plan for these events and what happens afterward. Remember, that you should have an attorney prepare a will/living trust document and to use an IRS Enrolled Agent for all taxes.
What to do when a loved one passes: first, call 911 unless the person is in a hospital or under medical care elsewhere. Then, call a relative or trusted person to comfort you and aid in immediate family notifications and personal immediate financial needs. A prepaid funeral plan is helpful here unless you have arrangements through the retired military advisors for a military funeral. After the funeral, there will be time to consult outsiders for advice and tax matters. Be aware of predatory financial advisors and insurance agents during this vital unstable period. Your finances will immediately change, so hopefully, you can go to the bank or savings/loan with access to a joint checking account, Living Trust account, or a personal account with a Power of attorney On Death [POD] form on file that will allow you access to the deceased’s account. Social Security will cease issuing any forthcoming monthly check but will issue a $255 check instead and close the account. Now the particulars for future reference:
Upon death a relative or spouse should contact the legal person who worked on the will or living trust. Death certificates will be provided by the County but you should request only one certified copy [they are expensive] because other copies can be made with newer color copying machines. The lawyer or executor [also heir in most cases] or lawyer will notify the County Court Clerk and pay a $200 fee. They will notify the court that the intestate person with no will, or has a will, or has a living trust. Probate is initiated for persons with or without a will to administer the estate through the courts. If the estate is minor, legal adjudication is not necessary at all. The party to a living trust can administer the trust provisions without the court’s sanctions or administration. Many people can carry out living trust provisions as executor or executrix without legal help. The trust should have provided for real estate title transfer from the trust to the surviving heirs. Pension providers should be notified that the pensioner has deceased. Brokerage, banks, and IRA firms holding investment or monetary accounts must be notified and death certificates provided if needed. Insurance companies will immediately pay the insured’s beneficiaries because they have access to the daily Social Security Deceased List which originates directly from the County Medical Examiner’s Office. IRA’s and pensions can be assumed by the heir or cashed in immediately. Your brokers or the pension administrator will assist in this matter. Extra caution needs to be taken here because it is an area prone to many errors and problems. If there is a will being administered by the courts, an attorney must be involved, and unless he is the executor of the estate, he is required to buy bond insurance for the estate in case an heir or other party takes money out before the final administration, diluting the rightful heirs of their share. Sometimes an estate is bankrupt if the assets or cash is less than $10,000, although an option is for either Series 7 or 13 is possible if there are assets to be disposed of. An accounting is required for all probate cases before they can be closed. All assets should be appraised or valued for fair market value at the date of death.
Horror stories prevail:
We conducted a forensic audit on an insurance-litigated case for an estate where one of the heirs/the executrix, went on a personal spending spree with the bulk of a large million-dollar estate. This resulted in a lawsuit by the attorney against the insurance company for payment of the bond. He won only when they made him prove the theft losses.
A law firm took on a multi-million dollar estate and forgot to file for an automatic six-month extension when the nine-month filing deadline passed. The statutory fees for the attorney in California are 4% times the first $100,000, 3% for the next $100,000, 2% of the amount over $200,000 to one million, and 1% of the amount over a million with additional amounts allowed for exceptional time to execute and administer. They are additive; that is, they are all added together and would total $23,000 to get to the first million of the estate. In this case the law firm was assessed late filing penalties exceeding the statutory fees. Most lawyers make lousy tax accountants and should delegate to keep out of trouble. Accordingly, tax accountants only practice tax law.
There were insurance annuities rolled over to new accounts instead of being paid to the beneficiaries. This usually generates commissions and litigation with loss of licenses. IRA accounts were rolled into new IRA accounts, then cashed with subsequent unnecessary prepayment penalties and taxes by the heirs. Special needs and requests of heirs can be ignored as ambitious financial advisors move funds around. One thing worth remembering is that the estate, which was created on the death of the individual, is responsible for all taxes unless assumed by the beneficiary as with an IRA or pension.
One client received a pension which was inadvertently directed to the fiduciary instead of going directly to the heir as intended. Accordingly, for five years we needed to file 1041 fiduciary tax returns to get the money out.
Another investment person directed a manager’s pension be paid back into the corporation and every year it must be taken out again. The insurance salesperson told the client it was a Rabbi Trust [which is a grantor trust] which made no sense at all. Sometimes, investment personnel and their supervisors have no tax knowledge [or brains] at all. It is worth careful consideration or second opinion concerning which investments or pensions should be sold, or cashed in by the estate VS assumed by the heirs. All administrators should only place funds in an ID number provided by the insured beneficiary. Aside from the new bank account required for a fiduciary, all new accounts must be signed by the heir or beneficiary. All new investment accounts should be reviewed by the investment advisor’s superiors because their firm is on the hook. Worth noting is that the heirs and family administrators are in a state of shock from the death of a family member and subjected to a barrage of unfamiliar events from these people.
It is not uncommon for insurance agents and stockbrokers to befriend church ministers and clergy for referrals on parishioner’s demise. Just days after the funeral they are knocking and calling on the heirs to offer investment and insurance advice. One insurance agent sold a widow an insurance policy on her to protect her children and a year later illegally canceled the policy and sold her a replacement policy while telling her it was a “Better Insurance Company”. This same agent sold an annuity to a widow who needed insurance policy funds to buy a house after her husband died. She canceled the annuity as planned a few months later and was surprised by the huge penalty for the early withdrawal. Most times commissions are the lifeblood engine of investment sales.
An elderly client, meaning well for her family, placed her three adult children on the title of a land lot to keep it out of her estate. Later, the land was attached with an IRS lien and levied for back taxes on one of her dependents. The IRS took the sales proceeds of the land leaving nothing for the other two heirs. Worth noting is that the IRS and State tax agencies are always checking computerized lists of bank accounts and real estate titles.
A fiduciary is created by the estate if there is property which cannot be assumed by a living spouse. The fiduciary files tax returns until the estate property has been distributed. It acts as a transitional vehicle to facilitate the sale of real estate and settlement of accounts for the estate. Property with beneficiaries such as pensions or insurance proceeds should not go to the fiduciary but directly to the beneficiaries. Real estate should be retitled to the fiduciary ID number so the heir can sign escrow documents and administer the transfer. Interest, dividends, and other income after the date of death go to the fiduciary which files income tax returns. Fiduciaries can direct taxes to be paid by beneficiaries on a K-1 form if the income is paid out or to pay the taxes with the return. A tax planning note: if there are heirs apparent, a senior citizen or terminally ill person can add his heirs to his residential trust deed which would short out the fiduciary process if this is the only major asset. This would assure the property could go outside of probate and fiduciary administration [he would not need to sign a bill of sale in escrow afterward [after he passes on], which is what a fiduciary normally does.
There usually a final 1040 tax return as well for the deceased with residual income included for the last year. Spouses can file as married during this final year and Widows or widowers with children can also receive special married marital tax status for two more years.
As of 2016, an estate has a Federal taxable exclusion of $5.45 million. Most people do not have millions in their estates so there is no required filing of the 706 forms within the required nine months. For large estates, if there is a surviving spouse, the estate is divided, and if the deceased’s property goes to the spouse, half is then applied to the non-applied exclusion and the balance can be carried forward to the surviving spouse so she is not taxed on the unused exemption [DSUE] again. In other words, his estate is now her estate but the executor/rix needs to take advantage of the exemption. Of course, all property willed out of the spousal estate is gone from her control and future taxes [this is done with a by-pass trust or simply by willing It away from the future estate of the surviving spouse]. At this time California has no estate taxes and no returns need be filed. Gone are the days when we would file the Federal 706, wait for the audit results [yes, they are all audited], and then send the audit letter to the Franchise Tax Board with the required state returns. Only nine months [an interesting gestation period] is allowed for 706 returns and the penalties for late filing can be horrendous.
Gift taxes apply to money or property given away in excess of $14,000 annually. This is for each spouse. If you give away six million, the amount taxed would be over a half-million dollars, after subtracting the annual gift tax exclusion and the estate exclusion. A rarely filed gift tax 709 return would be filed for this great event. All gifts above the $14,000 would be taxed in future years.
Well, I didn’t say it would be easy. Please seek legal or tax professional advice when needed.
* Phillip B Chute is an Enrolled Agent, tested, licensed, and appointed by the IRS directly. He has prepared or supervised over 25,000 tax returns over 30 years.