Is a Retained Life Estate or POD Account Part of a Taxable Estate? Navigating the $25 Million Estate Tax Case (Discussions From A Fb Community)

Friends,

Today, I wanted to share a few comments and discussions from attorneys in a private Facebook community on the topic of what is and is not included in a person’s taxable estate. This is a good question, so I wanted to share the comments from some of the lawyers, as well as some research on this topic.

None of this is legal advice, just observations and research – don’t rely on it and make decisions. Names and details have been blurred or edited for privacy reasons.

If you’ve transferred property but retained a life estate, or if you hold assets like Certificates of Deposit (CDs) with “Payable on Death” (POD) beneficiaries, these assets are generally included in your gross estate for federal estate tax purposes upon your death. This is a crucial distinction for estate planning, especially with significant asset values.

Key Takeaways

• Assets for which the decedent retained a life estate are included in their gross estate at their full fair market value on the date of death for federal estate tax purposes.
• “Payable on Death” (POD) accounts, such as CDs with designated beneficiaries, are also included in the decedent’s gross estate for estate tax calculations, even if they pass outside of probate.
• The concept that beneficiary designations or retained life estates automatically remove assets from a taxable estate for federal estate tax purposes is generally incorrect.
• A “step-up in basis” to the fair market value at the date of death may apply to assets included in the gross estate, potentially reducing capital gains tax for beneficiaries.
• The federal estate tax can be complex, and professional guidance from an experienced estate attorney is critical for accurate planning and compliance.

Table of Contents

• What is a Taxable Estate?
• Are Assets with a Retained Life Estate Included in the Taxable Estate?
• How Do “Pay on Death” (POD) Accounts Impact the Taxable Estate?
• What About the Step-Up in Basis?
• Why is This Confusing for Some Professionals?
• Action Items for Estate Planning
• Conclusion
• References

The scenario involves a potentially $25 million estate with properties where a life estate was reserved, and multiple CDs with adult children as beneficiaries. Let’s break down why these assets are indeed part of the taxable estate.

The confusion often stems from a misunderstanding of what constitutes the “gross estate” for federal estate tax purposes versus what passes through probate. While some assets may bypass probate, they can still be subject to estate taxes.

What is a Taxable Estate?

The term “taxable estate” refers to the value of a deceased person’s property that is subject to federal estate tax. The starting point for calculating this is the “gross estate.” The gross estate generally includes all assets in which the decedent had an ownership interest at the time of their death. This can encompass a wide range of assets, including real estate, bank accounts, investments, life insurance proceeds (under certain conditions), and other property. From the gross estate, certain deductions-such as debts, administrative expenses, and charitable bequests-are subtracted to arrive at the “adjusted gross estate.” After further deductions and the application of the estate tax exemption, the remaining amount is the taxable estate.

As Attorney CF succinctly put it in the original discussion:

“Gross estate = everything owned by decedent at death. Pretty simple.”

This fundamental principle is key to understanding the inclusion of certain assets.

Are Assets with a Retained Life Estate Included in the Taxable Estate?

Yes, assets where the decedent retained a life estate are included in their gross estate for federal estate tax purposes. This is governed by specific federal statutes, notably Section 2036 of the Internal Revenue Code.

This section states that if an individual transfers property but retains for themselves a “life estate”-meaning they continue to possess or enjoy the property, or retain the right to the income from the property, for their life-the full value of that transferred property is included in their gross estate at death.

The purpose of this rule is to prevent individuals from avoiding estate taxes by giving away assets while still enjoying the benefits of ownership during their lifetime. As Attorney DRR noted:

“When you transfer property while retaining a life estate in it, a specific federal statute includes the entire value of the transferred property in your estate for estate tax purposes. They shut down this loophole a LONG time ago.”

Attorney BT further elaborated:

“If you give it away, but reserve a life estate to yourself, then the full value of the asset is included in your estate at your death. You do at least get a step up in basis, unless some other exclusion applies.”

This highlights the tax consequences beyond just inclusion in the estate, which we will touch on later.

The value included in the gross estate is the fair market value of the property at the date of the decedent’s death, not the value at the time of the original transfer.

How Do “Pay on Death” (POD) Accounts Impact the Taxable Estate?

Like assets with retained life estates, “Payable on Death” (POD) accounts, such as Certificates of Deposit (CDs) or bank accounts with designated beneficiaries, are also included in the decedent’s gross estate for federal estate tax purposes. While these accounts are often referred to as “non-probate assets” because they typically pass directly to the named beneficiaries without going through the probate process, their exclusion from probate does not mean they are excluded from estate tax calculations.

The reason for their inclusion is straightforward: the decedent owned and controlled these funds up until the moment of their death. Therefore, they are considered part of the decedent’s estate for tax purposes.

As Attorney AH explained:

“Attorney LM yes they are. Doesn’t matter they pass outside probate. They owned at death so are includable.”

Attorney LM’s initial assumption in the thread was correct:

“I have always assumed that the pay on death accounts (CD’s) would be counted as estate taxable – so I’m commenting to see if all agree.”

The consensus among experienced estate attorneys is clear on this point.

What About the Step-Up in Basis?

An important consideration when assets are included in the decedent’s gross estate is the “step-up in basis.” If an asset, such as real estate with a retained life estate, is included in the decedent’s gross estate, its cost basis for the beneficiaries is “stepped up” to its fair market value on the date of the decedent’s death. This can be a significant advantage for beneficiaries, as it can reduce or eliminate capital gains taxes if they later sell the asset.

For instance, if a property was purchased for $1 million and is worth $5 million at the time of death and is included in the gross estate, the beneficiaries’ basis becomes $5 million. If they sell it shortly thereafter for $5 million, there would be little to no capital gains tax.

This “step-up in basis” applies to assets included in the taxable estate, regardless of whether they pass through probate or directly to beneficiaries (like POD accounts, although the basis step-up for financial instruments might be less impactful than for real estate).

Why is This Confusing for Some Professionals?

The distinction between probate assets and taxable estate assets is a common source of confusion. Many people, including some financial professionals, incorrectly assume that if an asset avoids probate, it automatically avoids estate taxes. This is not the case. The rules governing federal estate tax are complex and distinct from state probate laws.

As Attorney JH pointed out, if beneficiary designations alone could bypass estate taxes, the entire field of estate planning would look very different:

“Imagine if a beneficiary designation was all it took to keep things from being countable toward your taxable estate. We planners would be out of the job.”

This highlights the fundamental role of estate tax laws in preventing widespread tax avoidance. The fact that a CPA might offer incorrect advice on such a significant issue underscores the need for specialized expertise in estate tax matters.

Action Items for Estate Planning

1. Consult an Experienced Estate Attorney: Given the complexities of estate tax law, especially with substantial assets, it is crucial to work with an attorney specializing in estate planning and probate. They can provide accurate advice tailored to your specific situation and help navigate federal and state tax regulations.
2. Review All Asset Titling and Beneficiary Designations: Regularly review how all your assets are titled and ensure beneficiary designations reflect your current wishes and are aligned with your overall estate tax strategy.
3. Understand the Gross Estate Definition: Educate yourself on what constitutes the “gross estate” for federal estate tax purposes. This understanding is foundational to effective estate planning.
4. Request a Second Opinion: If you receive advice that seems questionable or conflicting, do not hesitate to seek a second opinion from another qualified professional. This is especially important for high-value estates.
5. Consider All Tax Implications: Beyond federal estate tax, consider state estate or inheritance taxes, as well as potential capital gains taxes for beneficiaries. A comprehensive plan should address all these aspects.

Conclusion

The question of whether assets with a retained life estate or POD beneficiaries are included in a taxable estate is unequivocally answered “yes” under current federal estate tax law.

The Internal Revenue Code specifically addresses these situations to ensure that the value of such assets is properly accounted for in the gross estate. While the nuances of estate planning can be challenging, understanding these core principles is vital for accurate tax compliance and effective wealth transfer.

Always seek specialized legal counsel to ensure your estate plan is robust and compliant with all applicable laws. Relying on CPAs or Financial Advisors or Unlicensed Legal Providers (Non-Lawyers) can make or break your entire portfolio. Always hire an attorney to work on estate matters.

I’d love to hear your thoughts on this. Have you heard anything different from the above?

Cheers,

Sid Peddinti, Esq.
A Collector Of Ideas And Discussions

References

• IRS. 2036-1 – Transfers with retained life estate.
• IRS. Estate Tax.
• Investopedia. Gross Estate.
• Nolo. What Is the Gross Estate for Estate Tax Purposes?
• IRS. Basis of Assets.
• American Bar Association. Estate Planning.