Sunday April 28, 2024

4.11.3 Transfers at Death

Transfers at Death

Bequest of Savings Bonds:  As a general estate and income tax planning strategy, decedents should give "good assets" to family and "bad assets" to charity.

Bequest to Charity:  If a charity receives the savings bonds, however, the tax result is quite different.

Transfers by Will or Trust:  It is extremely important for a decedent's will or trust to make specific bequests of savings bonds, i.e. IRD assets.

Testamentary Charitable Remainder Trust:  Another excellent planning strategy is for the decedent to transfer savings bonds to a testamentary charitable remainder trust (CRT).

Bequest of Savings Bonds
As a general estate and income tax planning strategy, decedents should give "good assets" to family and "bad assets" to charity. Good assets include stocks, real estate and cash. These assets do not generate an income tax liability to an estate or family and, in fact, receive a step up in basis at the decedent's death.

Bad assets include savings bonds, IRAs and commercial annuities. These IRD (income with respect to the decedent) assets pose an income tax problem to an estate or family. See Sec. 691. Specifically, the beneficiary of an IRD asset is responsible for the untaxed income attributable to the asset. In the case of savings bonds, the untaxed income is the savings bonds' accumulated interest income.

Example 4.11.3A

David Decedent owned a U.S. Series EE savings bond at the time of his death. The face value of the bond was $1,000 and the original purchase price was $500. David left the savings bond to his daughter Suzy. As an asset owned at time of death, the $1,000 savings bond is properly includable in David's gross estate for estate tax purposes.

Moreover, Suzy will have $500 of interest income when she redeems the $1,000 savings bond. The $500 of taxable income represents the untaxed interest income that accumulated during David's life. Finally, because this is an IRD asset, there is no step up in basis for Suzy. However, she might receive a partial income tax deduction to offset some of the taxable interest income if David's estate paid estate tax on the value of the savings bonds. See Sec. 691(c).

Bequest to Charity
If charity receives a bequest of savings bonds, however, the tax result is quite different. First, a charity is exempt from income taxes. Therefore, charity will not have to pay tax on the accumulated interest income when it redeems the savings bonds. Second, a bequest of the savings bonds to a charity produces a charitable estate tax deduction. Thus, the savings bonds pass to charity free of any income or estate tax!

Example 4.11.3B

David Decedent owned a U.S. Series EE savings bond at the time of his death. The face value of the bond was $1,000 and the original purchase price was $500. In his will, David left the savings bond to his favorite charity. As an asset owned at time of death, the $1,000 savings bond is properly includable in David's gross estate for estate tax purposes. However, David's gross estate will receive a $1,000 charitable estate tax deduction for the bequest to charity.

The charity will have $500 of interest income when it redeems the $1,000 savings bond. However, the charity is tax-exempt and, therefore, does not have to pay any tax on the $500. At the end of the day, the net effect is that the charity has the full $1,000.

Transfers by Will or Trust
It is extremely important for a decedent's will or trust to make specific bequests of savings bonds, i.e. IRD assets. Alternatively, the IRD assets may pass to charity as a residuary bequest. Basically, these are the only ways a donor may transfer savings bonds to charity. Unfortunately, a donor may not list charity as a co-owner or death beneficiary of savings bonds. See 31 C.F.R. 315.6. If savings bonds contain a co-owner or death beneficiary, those designations take precedence over a will or trust.

It is generally not recommended that a pecuniary bequest to charity be satisfied with IRD assets. While the estate will still receive a charitable estate tax deduction for the bequest, the estate may have to include the IRD on its income tax return. See Reg. 1.691(a)-4(a).

Some advisors suggest language designed to avoid the problem illustrated in the above example. The suggested language might be as follows: "I instruct that all of my charitable bequests and gifts shall be made, to the extent possible, from property that constitutes income in respect of the decedent." This area of planning is quite complex and competent legal counsel should review a donor's situation before proceeding. See PLR 9315016, PLR 9507008, PLR 9537011 and PLR 9845026.

Example 4.11.3C

Donald Decedent's will contained a $1,000 bequest to his favorite charity. At the time of his death, Donald owned a U.S. Series EE savings bond. The face value of the bond was $1,000 and the original purchase price was $500. The $1,000 savings bond is properly includable in Donald's gross estate for estate tax purposes. However, Donald's gross estate will receive a $1,000 charitable estate tax deduction for the $1,000 bequest.

Knowing the income tax problems associated with IRD assets, Donald's executor wants to satisfy the bequest with the $1,000 savings bond. However, the will did not direct the savings bonds to charity. Thus, the estate is the beneficiary of the savings bonds. As a result, the accumulated interest income is likely taxable to the estate and not the charity. Therefore, the executor's income tax return will have $500 of interest income when she redeems the $1,000 savings bond.

Testamentary Charitable Remainder Trust
Another excellent planning strategy is for the decedent to transfer savings bonds to a testamentary charitable remainder trust (CRT). The benefits of this strategy are similar in nature to a bequest of savings bonds. Specifically, a decedent's will or trust will transfer the savings bonds to the CRT trustee. Similar to the tax exempt status of a charity, a CRT is exempt from income taxes. Therefore, the CRT trustee will not have to pay income tax on the accumulated interest income when it redeems the savings bonds.

Under the four tier accounting structure, the accumulated interest income will be recorded in tier one. Thus, the CRT income beneficiary will realize this tier one ordinary income over the years. In some instances, the CRT income beneficiary will be taxable on only a portion of the original accumulated interest income. See Sec. 691(c).

A transfer of savings bonds to a testamentary CRT also produces a charitable estate tax deduction equal to the present value of the remainder interest. In large estates, this deduction may save significant estate tax. Thus, the savings bonds to testamentary CRT strategy can greatly reduce income and estate taxes.

Example 4.11.3D

Doug Decedent owned a U.S. Series EE savings bond at the time of his death. The face value of the bond was $100,000 and the original purchase price was $50,000. Doug left the savings bond to a CRT for his son. As an asset owned at time of death, the $100,000 savings bond is properly includable in Doug's gross estate for estate tax purposes. However, Doug's gross estate will receive a $40,000 charitable estate tax deduction, which equals the present value of the CRT's remainder interest.

The CRT will have $50,000 of interest income when it redeems the $100,000 savings bond. However, the CRT is tax-exempt and, therefore, does not have to pay any tax on the $50,000. Therefore, the CRT keeps and invests the full $100,000. As Doug's son receives CRT distributions, the applicable tier one interest income will slowly be realized.

Case Studies on Transfers at Death

Saving Taxes on Savings Bonds:   Ethel Peters is an 80-year old grandmother and has an estate valued at $2 million. She has one son, age 55, who is married with three children. Her estate consists of her home valued at $750,000, an IRA with a current balance of $100,000 and United States Savings Bonds (Series EE) with a current value of $250,000. The balance of the estate is invested in securities. Ethel primarily lives on her Social Security income, the IRA distributions and a small pension inherited from her husband.

Don't Sell the Bonds:   Bill and Karen Larson were married for sixty-two years. They had four children who now are adults and on their own. Bill was a careful saver, and a veteran of World War II. He regularly bought Series E savings bonds. Even though the bonds paid an interest rate of three to four percent, when Bill passed away the U.S. Savings Bonds inherited by Karen had a total value of over $3,000,000!

The CRT Solution for Savings Bonds:   Jackie Marshall, a widow age 82, owns a portfolio of Series EE savings bonds which she purchased back in the 1980's and 1990's for $150,000.
IRD Assets Make a Better Bequest:   James Johnson passed away two years ago and in his Will he had made various pre-residuary property bequests. He had also left the estate's residue in various percentages to a number of tax-exempt charities. In total, 25% of the residuary is to be transferred to charities. This 25% represents approximately $500,000 of the $2,000,000 estate. The Will gave the executor, Jeffrey Nelson, the power to sell any assets or to distribute assets in kind. Among the assets in the decedent's residuary estate were Series E Bonds that had accrued reportable income. James had not elected under Code Sec. 454(a) to report the bond interest annually and, therefore, the accrued interest on the bonds is income in respect of a decedent (IRD). Generally, the interest is treated as includable in the decedent's estate and is taxable to the decedent, the estate or estate beneficiaries. However, since neither James nor his estate elected to report the increase in the bonds' redemption price each year as it accrued (nor did the estate intend to do so), the beneficiaries of the estate would be required to report the accrued interest when the bonds are redeemed.

Private Letter Rulings

PLR 200002011 Unqualified Deferred Comp and Options Bequeathed to Charity:   Taxpayer has accrued a right to three different types of unqualified deferred compensation. He has compensation that has been payable but has been deferred, non-statutory stock options that he may exercise and a right of his estate to receive an additional amount of nonqualified deferred compensation.

TAM 200303010 No Valuation Discount Allowed For United States Series E Savings Bonds:   Taxpayer purchased Series E United States savings bonds. The value of the savings bonds consisted of the purchase price plus many years of accrued interest. Taxpayer recently died, and the bonds were distributed to Taxpayer's revocable trust. During the preparation of the estate tax return, Taxpayer's personal representative included the savings bonds in the gross estate. However, the personal representative reduced the overall value of the savings bonds when calculating the gross estate by claiming a lack of marketability discount.

PLR 200537019 IRD Includible in Decedent's Estate, but not Taxable:   Decedent's will provided gifts of cash and personal property to certain named individuals. The residue of the estate was to be divided equally among 10 named charitable organizations. The will granted the executor the power to make distributions or divisions of the estate in cash or in kind. The executor was also granted the power to give different kinds or disproportionate shares of property or undivided interests in the estate property to the named beneficiaries.

Related Topics on Transfers at Death

3.10.2  Four-Tier Accounting:    Unitrust payouts are one of the most important areas for the advisor to communicate to the recipient. With a charitable remainder trust, the basic payout rule is that the unitrust percentage is multiplied times the trust value and that amount is then distributed. The distribution may be monthly, quarterly, semiannually or annually.

3.2.3  Bequests of IRAs and Other IRD Assets:    Some assets transferred to heirs do not receive a stepped-up basis. This "income in respect of a decedent" (IRD) is defined as gross income "not properly includable in computing [decedent's] taxable income for the taxable year ending with the date of his death." Reg. 1.691(a)-1(b). IRD assets are those in which there is either untaxed ordinary income or a deferral of capital gain. When the beneficiary receives the asset, the beneficiary is subject to taxation on the asset, just as the original owner would have been subject to such taxation if he or she had recognized the income or gain.

4.11.1  Types of Savings Bonds:    U.S. savings bonds are government backed bonds issued by the Department of Treasury. The two common types are Series EE and Series HH bonds. However, many taxpayers may still hold other types of savings bonds, such as Series E and Series H bonds. With so many types of savings bonds issued over the past 50 years, some savings bonds past their final maturity date no longer earn interest income.

4.11.2  Transfers During Life:    Treasury regulations greatly restrict the lifetime reissue of savings bonds. 31 C.F.R. 315.6. Therefore, it is generally not recommended for a donor to attempt to reissue savings bonds in a charity's name. Even if a donor may reissue savings bonds in a charity's name, the accumulated interest income is still immediately taxable to the donor at the time of reissue. See PLR 8010082. Therefore, this may discourage a reissue during the life of the donor.

Brownstone:    In Clyde Brownstone et al. v. United States; No. 04-4061 (27 Sep. 2006), the Court of Appeals for the Second Circuit denied a charitable income tax deduction for a one million dollar transfer from a trust to an estate and then to charity.

      Quiz-Basic



© Copyright 1999-2024 Crescendo Interactive, Inc.