How Death Taxes Get Paid – Part 2

In this week’s blog post I continue discussing death taxes and how they get paid.  Last week I explained how estate taxes and inheritance taxes are calculated.  In each case the assets subject to the tax are not necessarily all within the control of the executor/administrator of the estate.  That’s because non-probate assets which go directly to named beneficiaries or surviving co-owners are not part of the probate estate that passes by way of the will.  Yet the executor/administrator is the person tasked with the responsibility to file the return and pay the tax.  That can be a problem if there are not sufficient assets in the probate estate.

Let’s look at an example of how this might play out.  John Doe did not have any children and his wife predeceased him.  His will left his assets to several nieces, nephews and friends.  What he did, however, was designate TOD/POD (transfer on death/payable on death) designations for some of his assets.  

John had a large non-retirement brokerage account that he made TOD to a niece and nephew.  He also left his home to a friend by way of a specific bequest in his will.  The brokerage account was valued at $800,000 and the home at $1,000,000.  He also had some smaller retirement accounts worth $400,000 that had named beneficiaries on death and other non-retirement bank accounts totaling another $300,000 with no beneficiary designation and no co-owners.

The total taxable estate was $2,500,000.  The first $15,000,000 of an estate is exempt from federal estate tax and New Jersey no longer has an estate tax so neither of these taxes would be an issue.  That leaves inheritance tax which is estimated to be $375,000.  One final relevant piece of information to this hypothetical estate.  John’s will had a tax clause which states that the tax is to be paid out of the residuary of the estate.

So to summarize, the probate estate has $1,100,000 (the home and non-retirement bank accounts).  Another $1,400,000 passes directly to heirs and is not within the executor’s control.  Because John has directed that the home – and not the cash from a sale of the home – be left to his niece and nephew, the executor does not have access to enough cash to pay the inheritance tax.  So what can the executor do?  We’ll cover that next week.