It is a wonderful time of the year, and it is also a time of giving. From a legal standpoint however, the Top 3 Things Not To Give To Your Kids are the following:
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Your House
There are a few reasons why people do this, including the fact that they believe they are being savvy in avoiding taxes. This is actually a mistake because there are two death taxes which apply to Pennsylvania residents. One type is the Federal Estate Tax, and the other is the Pennsylvania Inheritance Tax. For most people, the Federal Estate Tax may not apply due to the exemption allowed, which is $12 million each for husband and wife, with a total value of $24 million. Fortunately, most middle-class Americans do not have to be concerned about paying the Federal Estate Tax for the foreseeable future.
Inheritance Tax
Pennsylvania has an inheritance tax however, and the rate which you pay, depends on the relationship you have to the deceased person. If you pass away, leaving your money and assets to your spouse, there is no tax. Children and grandchildren must pay 4.5% tax, as well as the parents of the deceased child if they receive an inheritance. Based on an inheritance of $100,000, the tax would only be $4,500 which is not a huge amount. If you are wanting to avoid the Pennsylvania inheritance tax, you would have to give up control of your assets, but in my opinion, it is not worth doing so, simply to avoid your child having to pay tax.
People also want to protect the value of their house from long term care costs, if either mom or dad needs to go to the nursing home. Given that assets are taken into consideration for Medicaid eligibility, people think that by offloading assets and giving the house to the kids, is a smart move, but it is a mistake.
Be Aware of Capital Gains Tax
Something else to consider is that when you transfer a house or an asset that has grown in value, there is the stepped up tax basis you need to be aware of. If dad purchased a house in 1980 for $100,00, and it is now worth $300,00, there is a $200,000 capital gain. Should dad sell the house for $300,00 to pay for long term care, there is no tax on that house if it is the primary residence. However, if dad transferred the house to his kid, and the kid decides to sell the house, he would have to recognise the $200,000 capital gain as it is not the primary residence. Based on a rate of 15-18%, it will cost $30,000 in capital gains tax, which is a mistake.
Use an Asset Protection Trust
However, if dad died, having lived in the house until he passed, and leaving the house to his child, the child could sell the house, worth $300,000 without paying the $30,000 capital gains tax. It is better to leave the house to your kid when you pass away, rather than transferring the house while you are still alive. In the event of dad needing long term care, the house could be put into an Asset Protection Trust. Doing this protects the house from long term care costs, while preserving the stepped up tax basis, and this is a smart move. You can find out more by coming to one of our workshops which you can register for on sechlerlawfirm.com/workshops
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Filial Support Claim
If dad goes to the nursing home, and he runs out of money, but he is also not eligible for Medicaid, it means the nursing home is not getting paid for his care. The nursing home can sue the kids for the unpaid balance for their dad’s care. The Filial Support Law states that your kids may be held liable for your nursing home bill. This is true regardless of whether or not your kids received money from you as a gift. There are rules to follow if you want to be eligible for Medicaid. One rule is that no money should be given away within five years preceding the nursing home admission. This is known as the 5 year look back period. A family can avoid this liability by working with a qualified Elder Law Attorney.
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Unnecessary Tax Bomb
IRA accounts were once the best thing you could leave for your kids as an inheritance. If dad leaves his retirement account to his kid, the kid could let the money run for his life expectancy. He could also take annual distributions. The money could be tax deferred, so $200,00 was worth a lot more due to the tax deferred growth.
Enter the Secure Act in 2020
The IRS developed the Secure Act in 2020, so now money from IRA accounts must be distributed to the kids within the first 10 years after dad passes. This means there is no longer the benefit of tax deferred growth. If the kid receives the money before retirement, he is likely still working. He may already be paying high income tax rates, and the inheritance money will increase the tax he pays. It is the biggest tax heist against middle-class Americans. I advise you to consult with your financial advisor if this is a concern for you. Perhaps you will consider pulling some money out of your retirement account for this reason.
One of my clients wanted to leave an inheritance for his kids if he died before his wife. This inheritance was funded with life insurance. It was suggested that if he died before his wife, his kids should receive some IRA money. When his wife died some 10 years later, the kids would get another 10 years’ worth of money. The tax liability could therefore be stretched over 20 years, instead of 10 years.
The repercussions of bad decisions could mean your kids will lose out on receiving what you’ve worked hard to earn. Thus I urge you to think carefully about how to be tax efficient with your inheritance to your kids.
The 3 Things You Should Give To Your Kids
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An Inventory of Your Assets
This is helpful especially if you have asked your kid to be your Executor.
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A Copy of the Estate Plan with Will
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Their Own Estate Plan
Please remember that we are not giving you legal advice in these blog articles or radio show. If you need legal advice, please don’t hesitate to call us at 724 546 4227 or visit sechlerlawfirm.com
