The 19th century English author Leigh Hunt wrote “traveling in the company of those we love is home in motion.” Hunt recognized in this statement a fundamental reality that “home” is not so much a physical place as it is an expression of the most comfortable, most loving relationships in our lives.
For many people, the closeness of home and family are found outside of biological relationships.
We often find ourselves referring to an old friend as “like a brother” or a trusted adviser from childhood as “a second mother.” These references clearly reflect the individual, although not related by blood, is a close and faithful friend.
For many people, the relationship is so close the individual truly becomes a part of their family and instead of saying the individual is “like” a brother, they are simply referred to as a brother.
While most people can understand, and perhaps even empathize, with this sentiment, estate and tax laws are not quite as understanding. When creating an estate plan that will provide for non-biological or distantly related loved ones, understand the tax implications and be clear about the legal relationships.
There are two types of taxes we are primarily considering upon death – the federal estate tax and the state inheritance tax. Currently, the federal estate tax exemption is $11.58 million per person. This means any American can gift a total amount of up to $11.58 million during life – not including the annual gift exclusions – and after death without his or her estate paying federal estate taxes on the gift.
It’s important to note this limit is high and it includes nearly anyone with some exceptions.
The second type of tax is Kentucky’s inheritance tax. Not every state has an inheritance tax and Kentucky adds to the confusion by categorizing beneficiaries into three “classes.”
Class A beneficiaries include a spouse, parent, child, grandchild, brother, sister, half-brother and half-sister. These beneficiaries make up an exempt class, as their inheritance is not subject to Kentucky inheritance tax.
Class B beneficiaries include a niece, nephew, half-niece, half-nephew, daughter-in-law, son-in-law, aunt, uncle and great-grandchild. The exemption for this group is only $1,000, with any inheritance over that amount being subject to a tax of between 4 and 16 percent.
Class C beneficiaries include all other individuals not included in the first two categories. This class has an exemption of only $500 and the tax ranges from 6 percent to 16 percent. Notably, nieces and nephews by marriage, cousins and great-nieces and great-nephews are specifically included as Class C beneficiaries.
By reviewing these classes, it becomes immediately clear the legal relationship will make a tremendous difference in how much of an inheritance the individual actually receives.
In particular, unmarried couples, regardless of the longevity of the relationship, would be classified as Class C beneficiaries. Similarly, naming a son-in-law or daughter-in-law as a successor beneficiary rather than grandchildren would cause a loss to taxes.
Of course, understanding tax consequences of beneficiary designations should not lead to the disinheritance of individuals, but should instead help you to be more careful about the language and way gifts are made.
If you want to give without adverse tax consequences, consider giving during your lifetime rather than upon death. Instead of leaving gifts to children-in-law to use for the care of minor grandchildren, a better option might be to leave the bequest to the grandchildren in trust, with the surviving parent as the Trustee.
Above all, be intentional about your choices. Understanding tax consequences is one part of creating an estate plan, but ultimately, you should decide who you want to receive your property and how. If taxes are a concern, talk to an estate planning attorney and a CPA to create a tax-advantageous plan.
Cynthia Griffin is an elder law and estate planning attorney at Burnett and Griffin PLLC in Elizabethtown. She can be reached at [email protected].