The Elrod Firm


Joe Knows?

It was hard for me to believe that one guy could have so many firmly held but outright wrong beliefs as the man who sat before me in my conference room. The clients I work with are usually some of the most interesting and friendly people you’d ever want to meet. Unfortunately, Joe did not fit that description.

Joe was not friendly. He wasn’t interested in hearing my ideas on planning, either. Apparently Joe had scheduled an appointment in order to insist that I look over the estate plan he had put together himself. Although he knew that I was an estate planning attorney, he wanted me to tell him he didn’t really need an attorney and that his estate plan looked fine just how it was.

He’d done his research. One of the documents Joe had prepared for himself was a trust. He was quick to tell me that he knew all about probate court, and he was well aware that using a basic will would not keep him out of probate—that’s why he had chosen to use a trust. I wasn’t pleased with the direction that the meeting was headed, but I agreed to glance over the document to see what he’d done. It wasn’t great, but it appeared to at least be a legally valid document.

That was when things really started to go downhill. Joe explained that to make things “simpler,” he had decided to deed his home to his two children. I’m not sure why he thought deeding his home directly to his children instead of allowing it to pass through his trust would be simpler, but he was convinced he’d made a brilliant decision. Joe also knew he had to designate his trust as death beneficiary on each of his financial accounts to ensure they would pass outside of probate when he died. He had already done that, he explained, even with his large IRA.

Simply put, Joe knew just enough to be dangerous. His attitude soured as I explained that he had made two of the biggest tax-related estate planning mistakes possible.

First, with the home, he was correct that deeding it directly to his children would keep it out of probate court, but his kids would have been far better off if he would have allowed the home to pass through his trust instead, because of capital gains taxes. I explained to Joe that if his home were to pass to his children through a trust, the home’s capital gains tax basis would be reset as of the date of death, erasing a lot of potential taxes. Because he had deeded his home to his children while he was living, they would be forced to retain his capital gains tax basis, which would result in higher taxes when his children should sell the property.

Second, with the financial accounts, Joe was correct that death beneficiary designations to a trust are usually a great idea. That’s not the case, however, with his IRA. That was especially not the case with the type of trust Joe had. There are ways to pass an IRA to children while allowing them to keep the account tax deferred for their lifetimes, but passing an IRA through a typical trust is not one of those ways. By handling his retirement account in this fashion, he was actually forcing accelerated taxation on his children.

Like I said, Joe knew just enough to be dangerous.

I explained to Joe that he should have deeded his home to his trust so that his children could inherit the property, but he should not have directed his IRA to his trust. He had basically gotten his trust funding backwards, and it was going to cost his children a ton in taxes when he was gone.

Joe was a little embarrassed. I could tell he wasn’t going to allow me to help him fix the issues I had spotted, at least not today. So as he packed his things to leave, I handed him a copy of my book, You Need A Plan. I directed him to part two, which contains three chapters on the most common misconceptions people have about tax-related issues in estate planning. It clears up common myths about the estate and gift tax. It covers the specific capital gains tax pitfall that Joe had fallen into. It explains several far better ways to handle IRA funds than directing them through a typical trust.

Don’t be like Joe. Do your homework. Realize there is more to planning than just avoiding probate, and then work with someone able to simplify these complicated issues.


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