December 10, 2008

More ways you can mess up your estate plan—Part eight

By Robert P. Bergman
Special to the Times

The next installment in our continuing series of articles on “Ways You Can Mess Up Your Estate Plan:”

18. Failure to consider the income tax aspects of your assets

Marlene's two major assets were her life insurance and her (traditional) IRA; and they were of equal value. So she named her son as the beneficiary on the life insurance and her daughter as her IRA beneficiary.

The proceeds of life insurance are income tax free, but the proceeds from an IRA are generally all income taxable.

The daughter lost approximately one-third of the proceeds to income taxes.

We discourage our clients from leaving specific assets to specific persons.

Consider naming all children as beneficiaries, or, possibly, leaving your assets to your Living Trust, with the trust dividing them equally and providing who will receive them in the event a child should predecease you. In any event, there are significant tax consequences with the manner in which you pass on retirement plan assets such as IRAs and 401(k) plans. Don’t try to do this on your own.

19.Gifting highly-appreciated assets

(Failure to consider all the estate, gift, and income tax aspects of a gift.)

Mary was diagnosed with terminal cancer. She had heard that probate could cost her children thousands of dollars. She heard that probate could be avoided by deeding her home to her kids while she was alive.

Luckily, none of the problems we previously discussed under joint tenancy developed, such as a child's divorce, lawsuits, tax liens, etc. But when the kids sold Mary's home for $700,000 after her death, they discovered that their "cost basis" (cost for determining taxable gain) was Mom's cost 30 years ago, which was $150,000. The taxable gain was $550,000 and at a combined federal and California tax of 24.2 percent on the capital gain, the tax was $133,650.

Their accountant correctly informed them that if Mary had owned the property on her death (or if it were owned by her Living Trust), then her children would have inherited the property with a "step up” in the cost basis. That means that their new cost basis (or cost for determining taxable gain) would have been the fair market value on Mary's date of death, or the value of $700,000. There would have been no capital gains tax payable on the sale shortly after Mary's death. Mary's gift to avoid probate cost her children $133,650!

If the children acquire the home on mom's death (and not by gift) and did not sell it, but rented it out, they could take depreciation based upon its fair market value on mom's date of death.

20. Using the wrong assets to fund a gift to charity

Mark wanted to leave $20,000 to his church upon his death and the rest to his children. Mark's attorney was inexperienced in estate planning, and but for a very reasonable fee drafted Mark's Will as instructed: "$20,000 to my church and the balance equally to my children." Mark's large IRA passed to his children, who had to pay income tax on it.

Had Mark funded the charitable bequest with his IRA, there would have been $20,000 less taxable income to the children, increasing the amount that passed to them after income taxes by, perhaps, $6,000 (at a 30 percent rate for both federal and state income taxes.) Charities don't care if they receive taxable income, as they don't pay income taxes anyway.

Michael saved a few dollars on the drafting side which later, in effect, cost his children $6,000!


Robert P. Bergman is a San Jose estate planning attorney and counselor who devotes his law practice exclusively to assisting individuals and couples plan for incapacity and the eventual transfer of their property to their heirs. Bob specializes in working with parents who have minor children. Bob gives a regular monthly seminar at the Jewish Community Center in Los Gatos entitled “Everything You Wanted To Know About Estate Planning, But Were Afraid to Ask!” Visit his Web site at www.lawbob.com where you can learn more, get on his mailing list, register for an upcoming seminar, schedule a consultation, and read other articles on estate planning topics that Bob has written. You can also reach him by e-mail at rpb@lawbob.com or telephone at (408) 247-0444. All inquiries are confidential. This column is intended to provide general information about estate planning ideas, concepts, and laws, and is not to be relied upon as rendering legal advice about your particular situation. No attorney-client relationship is created by these articles. The laws concerning estate planning, wills, trusts, and estate taxes are very complex, often state-specific, and change on a regular basis. Consult with an experienced attorney before taking any action that would affect your personal or business matters.