Post-Mortem tax savings for Series E and EE U.S. Savings bonds.
With millions of people owning savings bonds, it is not unusual to find them in an estate. When this happens, the executor should determine if the deceased was a cash-basis or an accrual basis taxpayer. Cash-basis taxpayers are not required to report the current interest on Series E and EE U.S. Savings Bonds. A taxpayer who chooses to defer the accrued interest does not recognize the entire interest amount until the bonds mature, are redeemed or otherwise transferred in a taxable transaction. When a cash-basis taxpayer has chosen to defer the accrued interest, the executor of the estate has two choices:
1. Elect under Sec. 454 to include on the decedent's final return all interest accrued on the bonds from their acquisition date to the decedent's date of death; or
2. Make no election on the decedent's final return and allow interest to be taxed at the cash-basis estate level or the beneficiary level, or both.
The first choice may allow the executor to take advantage of lower income tax rates and may also reduce the taxable estate. The income tax rate reaches 39.6% for estates and trusts with taxable income exceeding $8,350, versus $278,450 for married persons filing jointly or single individuals (using 1998 rates) . This rate differential, when combined with other specifics of a decedent's estate, can provide reason to bring the accrued income into the decedent's final income tax return. For instance, if income is low in the decedent's final tax year (either because death occurred early in the year or because deductions such as medical expenses and taxes were substantial), the decedent's taxable income without the election could be low or even negative. Also, if the decedent has deductions that will terminate on death (such as net operating losses, charitable contribution carryovers or capital loss carryovers), the executor should consider accelerating income on the decedent's final return. Finally, any income tax liability generated becomes a liability of the estate, which could reduce the estate tax.
Before an election is made, other considerations that may offset the potential benefits of the election should be investigated. For instance, interest recognized on the decedent's final income tax return is not considered income in respect of a decedent (IRD); thus, the executor and/or beneficiaries would not be allowed a deduction for estate taxes attributable to income that they might otherwise receive. Further, if the estate or beneficiaries do not dispose of the bonds in the near future, the election accelerates the income tax due; therefore, the time value of money of that tax must be considered.
The second choice is not to elect Sec. 454 on the decedent's final return and determine whether to have the IRD taxed at the cash-basis estate income tax level or passed to the beneficiaries. If Sec. 454 is not elected on the decedent's final return, the interest accrued from the acquisition date to the date of the decedent's death is IRD (Rev. Rul. 64-104). If the bonds matured, were sold by the estate or the estate elected Sec. 454, the IRD and the interest earned after the date of death is taxable. The executor should consider electing Sec. 454 at the estate level if the estate has high administration or other deductible expenses that could offset the IRD. Sec. 454 would be binding on the estate for all later years (unless the IRD consents to a change), but would not be binding on the beneficiaries to whom the bonds are later distributed.
If the estate has no expenses to help offset the IRD, the bonds should be passed on to the beneficiaries. This is especially advantageous if the beneficiaries are in a lower tax bracket than the decedent. The cash-basis beneficiaries could also choose to continue to defer the accrued interest until maturity.
If the IRD is taxed at either the estate income or beneficiary level and the estate was subject to estate tax, the estate or the beneficiary can claim a deduction for the estate tax related to the IRD.
The accrued interest can be a substantial part of the value of Series E and EE bonds. Sec. 454 is an opportunity for a tax adviser to offer assistance not only to the estate executor or personal representative, but also to the beneficiaries.
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|Author:||Brodnax, Frank E.|
|Publication:||The Tax Adviser|
|Date:||Oct 1, 1998|
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