Poor estate planning might result in several forms of tax dues

Given the high federal threshold for federal estate tax, over $5.4 million for tax year 2016, readers may assume that they don’t need to worry about taxes in their estate planning. However, that assumption could lead to several nasty surprises.

First, Pennsylvania imposes an inheritance tax that is a percentage of the value of the decedent’s estate. The type of family relationship determines the tax rate, with zero percent imposed on surviving spouse transfers or children 21 years of age or younger; 4.5 percent on transfers to direct descendants; 12 percent on sibling transfers; and 15 percent on transfers to other heirs.

In addition, assets in an estate plan may be also subject to income tax. For example, any non-spousal beneficiaries of a traditional IRA or traditional 401(k) generally must pay income tax. The rationale is that the funds in traditional retirement accounts were invested pretax, and thus have not been taxed yet. Fortunately, a beneficiary can spread out the withdrawals/payments and resulting income tax obligation over his or her expected lifespan.

However, there may be smarter ways to transfer retirement assets to one’s heirs. It may be possible to convert traditional IRAs and 401(k)s to Roth accounts. Although a conversion will trigger income tax, the account could be converted in several steps to avoid pushing the account holder into a higher income tax bracket.

To lower the value of the gross estate, it may also be worthwhile to explore irrevocable trusts. Since a decedent could not exercise control over the assets in that type of trust, the value of the trust assets may not be included in the calculation of the gross estate’s value.


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