WHO’S LAUGHING NOW?

A “laughing heir” is a euphemistic term that estate planners use to describe a person who inherits money from a relative with whom he had little or no relationship. For example, a nephew inherits money from his unwed, childless uncle, who he rarely, if ever, visited. The nephew is said to be a laughing heir because he had no personal relationship with the uncle, yet he is now receiving a financial windfall in the form of an inheritance.

But laughing heirs aren’t always as happy as the euphemism may portray them to be. In fact, many heirs, laughing or grieving, aren’t as happy about their inheritances or the manner in which they receive their inheritances, as one might think.

When a person dies, their debts must be paid. Typical debts include the funeral, medical bills, nursing home bills, and basic, every day bills. Sometimes, estate taxes must be paid. Possible estate taxes include federal estate tax, New Jersey estate tax, and New Jersey Inheritance Tax. Finally, a decedent’s income tax must be paid for any income that was earned or unearned up until the date of death; income earned after the date of death is reported on the estate’s income tax return.

Let’s assume that a man named “Frank” died and that Frank had $800,000 worth of assets at the time of his death, including his house. Let’s further assume that Frank left his entire estate to his surviving brother and to his seven nieces and nephews, who are the children of two sisters who predeceased him.

Frank’s Will indicates that the brother is to receive one-third of his estate, that a niece and two nephews (the children of one of his predeceased sisters) are to receive one-third of his estate, and that two nephews and two nieces (the children of the other sister) are to receive the remaining one-third of his estate.

Finally, let’s assume that this is not a close family. None of the heirs were that close with Frank, though one of the nephews lived near Frank and helped him pay his bills. Frank placed this nephew’s name on a checking account that Frank used to pay his bills. At the time of his death, the checking account held $75,000.

Given the above scenario, Frank’s estate will be responsible for the payment of both New Jersey estate and inheritance tax. His estate exceeds $675,000, which is the credit given against New Jersey estate tax, so the estate must pay tax on that amount of assets that exceeds the credit, or $125,000.

Frank left his entire estate to a brother and nieces and nephews, who are “class C” and “class D” beneficiaries, respectively, for purposes of New Jersey Inheritance Tax. If an estate has beneficiaries other than “class A” beneficiaries – who are parents, spouses, children, grandchildren – the estate must file and, often, must pay New Jersey Inheritance Tax.

In most of the estates that I administer, the heirs – or more appropriately, the executor who is my client – will ask what planning can be done to avoid these taxes. The honest answer is very little.

Frank could have planned to avoid estate and inheritance taxes before his death. After his death, there isn’t much that can be done in the form of planning. On the date of his death, Frank had assets worth $800,000. After taking certain deductions for legitimate expenses that the estate paid – such as medical expenses, funeral expenses – the estate will have a net value. The net value of the estate will then be used to calculate the taxes owed.

If there are assets that have a value capable of being interpreted, then perhaps some planning could be done with those assets, but many assets have a definite value. For example, a bank account is worth what it was worth on the date of death. The value of a house is subject to interpretation, so it could be valued on the low-end of the scale for purposes of death taxes; however, valuing such an estate on the low-end of the scale for death taxes could cause additional income tax liabilities when the estate goes to sell the house.

Another question that may come up is, who pays the tax? Is the tax taken from the brother’s and all of the niece’s and nephew’s shares of the estate equally or proportionately? This depends on the tax clause that Frank had drafted into his Will. Many lawyers fail to pay attention to the tax clause they place in a Will, but the tax clause could have a significant impact on an heir’s share of the estate.

Finally, the heirs will have to realize that just because Frank’s Will says everything is divided into thirds, doesn’t mean that it will be. For example, the $75,000 bank account that Frank held with his one nephew will automatically pass to that nephew. Frank might not have intended this, but this is what will happen.

Even laughing heirs have a difficult time finding humor in these issues. Planning ahead of time can substantially reduce family acrimony on one’s passing.