Apportionment of estate taxes

The Facts: I recently inherited a beachfront house that has been in my family for generations. Although it was quite modest when first built, the house has appreciated tremendously over the years.  As a result of the inheritance, the value of my estate is now in excess of the estate tax exclusion amount. I do not have a spouse and only have one child. I intend to leave the house, by far my most valuable asset, to my daughter. I will be leaving the rest of my estate to my nieces and nephews.

The Question: Is there a way to allocate the estate tax between by daughter and my nieces and nephews even though I will not be leaving my daughter any liquid assets?

The Answer: The quick answer is “Yes”. Estate tax is calculated based upon the value of all of the assets you own or have control over at the time of your death. Generally, the tax is paid by the estate before any distributions are made to the beneficiaries. When an estate is liquid, it is easy for the executor to simply take the taxes and the expenses associated with the administration of the estate “off the top” and to then distribute the remaining liquid assets in accordance with the terms of the Will.  Where, as here, your most valuable asset is the beachfront house which is passing to your daughter “in kind”, your executor will be forced to pay the estate tax from the liquid assets that are earmarked for your nieces and nephews. However, you can condition the transfer of the beachfront house to your daughter upon her contributing a pro rata share of the estate tax. By doing so, the executor will be able to apportion the tax liability between all of the beneficiaries based upon the value of their respective bequests without giving consideration to whether or not the assets are liquid.

How It Works: Since the estate tax exclusion amounts are increasing annually and the real estate market is somewhat volatile, it is impossible to know in advance if the estate will be subject to estate tax and, if there is tax due, how much of the estate tax liability will be attributable to the value of the house. Despite this uncertainty, your attorney can include language in your Will describing the methodology you want used to apportion the estate taxes between the beneficiaries. For example, your Will may direct your executor to first calculate the total estate tax liability (the “tax”), then to determine the percentage of the value of the estate attributable to the beachfront house (the “%”) and finally to multiply the “tax” by the “%”.  The product will be your daughter’s proportionate share of the total amount of the estate tax that is owed. By way of illustration, if the estate tax liability is $60,000 and the value of the house accounts for .6666% or 2/3 of the value of your estate, your daughter’s share of the estate tax would be $40,000. ($60,000 X (2/3) = $40,000) and the share of estate taxes attributable to the other beneficiaries would be $20,000 ($60,000 X (1/3) = $20,000).

Although it may seem harsh to require your daughter to contribute a share of the estate taxes that are due in order to get title to the house, if you feel strongly that the taxes should not all be taken from the share of your estate that is passing to your nieces and nephews, there really is no good alternative.  If you decide to apportion the estate taxes, I suggest that you discuss this matter with your daughter in advance so she is not surprised to learn that she will be expected to contribute a share of the funds need to pay the estate tax. In addition to eliminating the element of surprise, advance notice will also give your daughter an opportunity to put some money aside for the taxes or to look into ways to quickly obtain cash after your death. Since she will become the owner of the beach house after you die, she will likely have the option of borrowing against the house if other sources of funds are not available to her.

This article first appeared in the November 11, 2016 issue of the Times Beacon Newspapers.

Linda M. Toga, Esq. provides legal services in the areas of estate planning, probate and estate administration, real estate, small business service and litigation from her East Setauket office.