Wills, probate, and what passes outside it

Probate is the court-supervised process of collecting what the deceased owned in his or her own name, paying the bills, and handing out the rest. It is governed by state law, not federal tax law, and by itself it costs no tax. What surprises families is how much passes outside it — anything with a named beneficiary, a joint owner, a beneficiary deed or a trust — and that the will has no say over any of that. One caution: this is a tax preparer’s explanation, not legal advice. It is meant to start the conversation with your attorney in the right place; the documents themselves should be drafted by one.

What probate is

When someone dies owning property in his or her own name — a bank account, a brokerage account, a house, a car, the furniture — somebody has to be given legal authority to collect it, pay what is owed, and distribute what is left. That is probate. A court appoints a personal representative (the executor if named in a will, the administrator if there is no will), confirms the will is valid, oversees an inventory, gives creditors a window to make claims, and approves the final distribution. It typically takes six months to a year and costs attorney and representative fees.

For income tax purposes the probate estate is a separate taxpayer. If it earns $600 or more in a year while being settled — interest, dividends, rent, a gain on selling the house — it files Form 1041, and the state’s fiduciary return with it where the state has one. That part is covered in When a loved one dies.

The procedure is set by state law. Many states offer a simplified, largely paperwork-driven form of probate for uncontested estates, with formal hearings reserved for contested wills or complicated situations. States also set a deadline for opening probate after a death, so the family should not let the question sit.

What goes through probate, and what does not

The right-hand column is the one that surprises families. The will has no say over any of it. If Dad’s will leaves everything equally to three children, but his IRA names only the oldest and his house is in joint tenancy with the youngest, the IRA goes to the oldest, the house goes to the youngest, and the will divides what is left — which may be very little. Beneficiary designations and titles override the will every time, and they are the thing most often left un-updated after a divorce or a death.

This cuts both ways. Used deliberately, the right-hand column is how many families avoid probate without a trust: a beneficiary on every account, a beneficiary deed on the house, and a will that only has to catch the car and the furniture. Used carelessly, it undoes a careful will.

For a small estate, most states let the heirs collect personal property (not real estate) by a sworn small-estate affidavit without opening probate, if the total is under a dollar threshold the state sets.

Dying without a will

Without a valid will, the state’s intestacy statute writes one for you. The details vary by state, but the usual pattern is this: the surviving spouse takes everything or the largest share, with the shares divided when there are children from another relationship. With no spouse, the children inherit equally; with no children, the parents; then siblings; then further out. The state is the heir of last resort. A will lets you do what the statute cannot: leave something to a friend, a church or a step-child; leave unequal shares; name who should raise a minor child; and choose the person in charge.

A will must be in writing, signed, and witnessed by two people. Some states also recognize a holographic will — in the testator’s own handwriting, signed, no witnesses — which is better than nothing and worse than almost anything else. A will is changed by a codicil or replaced by a new will that says it revokes all earlier ones. Many states permit a separate signed personal property memorandum, referred to in the will, listing who gets the watch, the ring, the gun collection — and it can be rewritten without redoing the will. Those items start more family fights than the money does.

Review the will when a child is born or adopted, when anyone named in it marries, divorces or dies, and when wealth changes substantially. In many states a divorce automatically revokes provisions in favor of the former spouse, but do not rely on that; rewrite the will.

Choosing the executor

Being named executor is not an honor; it is a job — collect everything, pay everyone, distribute the rest, keep records, file the returns, under deadlines, usually without pay, with personal liability for mistakes. The person should be organized, available, on speaking terms with the family, and willing. An out-of-state executor is generally allowed but adds friction. Always name a successor. For a large or complicated estate, or a family that does not get along, a bank trust department or a professional fiduciary earns its fee.

The executor need not be good with paperwork; the estate’s attorney and accountant do the technical work. What cannot be delegated is judgment and attention — and the executor is personally liable for the decedent’s and the estate’s unpaid taxes if the estate is distributed before they are paid. Two IRS forms protect the executor: Form 4810 forces the IRS to assess any tax on filed returns within 18 months, and Form 5495 requests a discharge from personal liability.

The revocable living trust and the pour-over will

A revocable living trust is a container you create during life, name yourself trustee of, and retitle your assets into. While you live, nothing changes: you control everything and report all the income on your own return (see Trusts and taxes). At death the successor trustee you named takes over without a court and distributes or holds the property under the trust’s terms. That is the probate avoidance everyone talks about. It also provides for incapacity and keeps the estate out of the public court file.

Two cautions. The trust only avoids probate for property actually titled in it; an unfunded trust — signed and put in a drawer while the house and accounts stayed in the owner’s name — is the most common failure a preparer sees. And a trust always comes with a pour-over will, a short will saying anything left outside the trust at death goes into it. The pour-over will still has to be probated if there is anything for it to catch, so the point is to leave it nothing to do.

The documents for while you are alive

• Durable (financial) power of attorney. Names someone to manage money, property and legal affairs if you cannot; without one, the family’s alternative is a court conservatorship. It ends at death, when the executor or trustee takes over. It does not let anyone deal with the IRS for you; that takes a separate Form 2848.
• Medical durable power of attorney. Names who makes health care decisions when you cannot.
• Living will (advance directive). Your own instructions on life-sustaining treatment when there is no reasonable expectation of recovery. Each state recognizes it under its own statute; the form has to follow the statute to be honored.
• A letter of instruction. Not a legal document: where the documents are, who the advisors are, the account list, funeral wishes. Keep the original will where the executor can get to it — not only in a safe deposit box the executor may not be able to open.

Saying no to an inheritance: disclaimers

An heir can refuse an inheritance or a gift. Done correctly it is a qualified disclaimer: the law treats the property as never having passed to the person who refused it, and it goes to whoever is next in line under the will, the trust or the beneficiary form — with no gift from the disclaimant. Done incorrectly, the refusal is itself a gift from the heir. The rules are strict: the refusal must be in writing, delivered to the executor or trustee within nine months of the death (or of the heir’s twenty-first birthday, if later); the heir must not have accepted any benefit from the property first — not the dividends, not a month’s use of the house (paying the property taxes from your own pocket is not acceptance); and the property must pass without any direction from the person disclaiming, to someone other than that person, except that a surviving spouse may disclaim and still take as the next beneficiary. It can be partial.

Why anyone does it: a child who does not need the money disclaims so it passes to the grandchildren (mind the generation-skipping tax); a surviving spouse disclaims part of an estate so it funds the bypass trust the will provided for; a primary IRA beneficiary disclaims so the contingent beneficiary inherits the account directly. Most states have their own disclaimer statute, and the disclaimer must be valid under state law as well. The decision has to be made before anything is touched, which is why a preparer raises it in the first conversation after a death rather than the last.

Where the tax questions come in

• How property passes decides its basis for the heir. Inherited property steps up to date-of-death value however it passes — but property given during life keeps the giver’s basis. Putting a child on the deed “to avoid probate” is a gift of half the house with the parent’s old basis; a beneficiary deed, where the state allows one, does the same job with a full step-up. See Inherited property and the step-up.
• Joint tenancy with someone other than a spouse puts the whole asset in the first owner’s taxable estate unless the survivor can prove contribution — rarely a tax problem under a $15 million exemption, but it strips the executor of assets to pay the bills.
• Who pays the income tax while the estate is open follows the will’s drafting. A beneficiary who receives only a specific dollar amount or a specific item gets no K-1 and carries out none of the estate’s income; the residuary beneficiaries carry it all.
• A surviving spouse who inherits everything may want the estate to file a Form 706 anyway, to lock in portability of the unused exemption. See Gift and estate taxes.
• The estate’s Form 1041, the decedent’s final 1040, and the ten-year clock on an inherited IRA are covered in When a loved one dies.