Gary, Fallston: My aunt in New York State recently passed away. Her estate (less than $1 million) is in the process of being settled. According to the will, I will receive 25 percent of the estate. Responses to my questions regarding taxes on what I receive have been varied and confusing. Answers range from no taxes, state or federal, to having to pay federal taxes and taxes in both New York state and Maryland or taxes in one state or the other. Since I reside in Maryland and pay state taxes here, it does not seem as though I should have to pay New York taxes also.
SC&H Group: There is not a direct answer without knowing several other pieces of information. However, you should be aware of the different taxes that can impact an estate. First there are estate and inheritance taxes, which are taxes based on the fair market value of the assets held at the time of death. The rules for the federal and New York estate taxation are different. The estate might also incur individual income tax that has to be paid from the estate for the income from January 1 of the year of death until the date of death.
Finally, there is a fiduciary income tax, which is the income generated from the date of death during the course of the estate being administered. If the estate receives income (interest, dividends, capital gains, etc.) and you receive 25 percent of this income, then you may receive a tax statement from the estate for your share of the income. Depending on the timing of the estate being closed, the estate may pay the tax on this income or it may distribute the income to you and then you would be responsible for the income tax. Typically, in that situation, you would owe federal and Maryland taxes. However, if the estate has New York source income, such as a family business or real property sited in New York, then you would report that portion of income on a New York Non-Resident income tax return and pay tax on that portion to New York.
In summary, there are several layers of taxation that could be involved in your situation, dependent upon the type of property owned by the estate and the timing of the closing of the estate.
Valerie, Pocomoke, Va.: My father "gifted" his house to my sister and me in October 2005. He retained lifetime rights. He passed away in June 2006 and we sold the house in December. Do we owe capital gains tax? If so, on what portion?
SC&H Group: The tax basis that you and your sister will have in the house will be the same as your father's basis increased by a proportional amount of any gift tax that he paid when he transferred the house to you. Assuming that he purchased the house, your dad's basis would be the cost that he paid plus any improvements made to the house. The gift tax is allocated by multiplying the appreciation in the house at the date of the transfer (fair market value less your dad's basis) divided by the fair market value of the house on the date of the transfer multiplied by the gift tax paid. Your gain would be the difference between the amount you sold the house for and the tax basis reduced by any costs of the sale. You would have a long-term holding period, since your father's period carried over to you, thus the gain would be subject to preferential long-term capital gains rates.
Sean, Bel Air: I have a Heath Savings Account through work. I pay in and my employer does as well. Are there any special steps I need to take to report this account?
SC&H Group: You should receive Form 5498-SA, HSA, Archer MSA, or Medicare Advantage MSA. This form shows your contributions and your employer's contributions for 2006. Your employer's contributions are reported in box 12 of your 2006 W-2, with a code W.
You will need to report all contributions made to your HSA on Form 8889, Health Savings Accounts. This form calculates your HSA deduction, and is filed with your 1040. The deduction you calculate flows to line 25 of your 1040.
Please note that you are allowed to make contributions to your HSA for 2006 until April 17, 2007. There is a limit to how much you can contribute each year.
John, Eldersburg: A taxpayer 70 1/2 (or older) has two traditional IRAs, one with a balance of $20,000 consisting of $6,000 of nondeductible contributions and $14,000 of deductible contributions and earnings. The second IRA has no nondeductible contributions. When a direct transfer of $1,000 is made from the first IRA to a qualified charity by the IRA trustee, how is that tax-free exclusion reported on Forms 1040 and 8606?
SC&H Group: A new provision added to the Internal Revenue Code in 2006 allows taxpayers that have reached the age of 70 1/2 to "distribute" up to $100,000 directly from an IRA to a qualified charitable organization without being subject to taxation on such distribution. In general, a distribution from an IRA is treated as partially taxable and partially excluded from taxable income in cases where the taxpayer's IRA contains both deductible and nondeductible contributions. However, a special ordering rule also was added to the Internal Revenue Code in 2006 with respect to distributions directly from IRAs to qualified charitable organizations. In those cases, the distribution is first treated as a taxable distribution. To the extent the distribution exceeds the taxable portion of the IRA, the balance is treated as reducing the nontaxable portion of the available proceeds.
In the example presented above, the entire $1,000 distribution to the qualified charity is treated as being made out of the deductible contributions and earnings of the IRA (i.e., entirely out of the $14,000 balance). Based on these rules, none of the $1,000 distribution is included in the taxpayer's gross income. Further, the taxpayer is not entitled to a charitable contribution deduction on his/her individual tax return.
For purposes of filing Form 8606, a qualified charitable distribution is not treated as a distribution. If the only distributions made from the IRA during the tax year were qualified charitable distributions, then the taxpayer is not required to file Form 8606.
For purposes of completing Form 1040, enter the total amount of the distribution on line 15a. If the total distribution is a qualified charitable distribution, then enter $0 on line 15b. If only a portion of the distribution is a qualified charitable distribution, enter the amount of the distribution that is not a qualified charitable distribution on line 15b.
PSB, Baltimore: How come when you take a distribution of your tax deferred savings after retirement, you have to then pay federal income taxes on your Social Security income for the year in which you took the distribution?
SC&H Group: The amount of tax you pay on your Social Security income depends on how much provisional income you have. Your provisional income is made up of all your other income; including tax exempt interest income and taxable retirement distributions, plus one half of your Social Security income. You compare your provisional income to the adjustments you have on your 1040, page 1 line 36.
If your provisional income after adjustments exceeds the threshold for your filing status ($32,000 for married filing jointly, $25,000 for single, head of household, and qualifying widower), then you will be taxed on a portion of your Social Security income. Social Security benefits are not taxable in Maryland, and you may be eligible for a pension exclusion -- see the instructions to Form 502 for more information on those items.
Answers to selected questions are published on Mondays.