Beneficiary Tax Obligations on Payable on Death – POD Accounts
Are POD accounts taxable? Yes and No
A payable on death (POD) account is an estate planning tool that provides a way for an individual to pass money to a beneficiary without the necessity of probate when he dies. He can name his beneficiary on the account, and she can access the money by presenting the original death certificate to the bank or institution where the account is held. The executor of the deceased's estate does not have any control over the funds.
There's no limit to the amount of money or the number of accounts that can be passed to beneficiaries in this way. But, you should be aware of the potential tax and other consequences of inheriting a POD account before you start spending the money.
Income Tax Consequences
The date of death value of a POD account generally will not be included in your taxable income because bequests aren't taxable as income. Any income earned by the POD account prior to the date of the account owner's death will be reported on her final income tax return. Income earned between the date of death and the date you take over ownership of the account should be reported on the account owner's estate's income tax return.
After that, however, any and all earnings become taxable to you.
Inheritance Tax Issues
The beneficiary pays inheritance taxes at the state level. The federal government does not impose an inheritance tax. But, you might well owe the tax on the value of the POD account that transfers to you if the decedent held it or died in one of the six states that have an inheritance tax. As of 2019, those states were Nebraska, Iowa, Kentucky, Pennsylvania, New Jersey, and Maryland.
The inheritance tax rate is as much as 18 percent in Nebraska, so you could owe the government $18,000 if you inherit a $100,000 account. But there's a bit of good news here. The more closely related you are to the decedent, the less of a rate you'll pay.
Surviving spouses are typically exempt from this tax entirely, and some states exempt the deceased's children as well. Beneficiaries who aren't related to the decedent can expect to pay the highest rates.
Estate Tax Consequences
Although POD accounts bypass probate, the decedent's probate estate and his taxable estate are two different things. His taxable estate is the value of everything he owned at the time of his death, regardless of whether it requires probate to transfer to a living beneficiary.
If the account owner's estate is large enough to be subject to federal estate taxes or state estate taxes, the provisions contained in his will or living trust documents might indicate whether you'll be required to contribute to the payment of any estate tax bills. The estate is technically responsible for paying any estate tax, but this isn't to say that the deceased's personal wishes won't direct otherwise.
Only very wealthy estates have to worry about this, however. As of 2020, estates with values over $11.58 million must pay an estate tax on the portion of their values over this amount—all value up to this amount is exempt. Twelve states and the District of Columbia also have estate taxes, however, and some of their exemption amounts are much lower. For example, exemptions are just $1 million in Oregon and Massachusetts as of 2019.
If the account owner did not have a will or trust, the laws of the state where she died should dictate whether you'll be required to contribute to the payment of any estate tax that's due, even though the account wasn't part of the decedent's probate estate.
Paying the Account Owner's Outstanding Bills
Technically, a decedent's debts should be paid from his estate as part of the probate process. Probate assets can be liquidated to provide payment to his creditors, but this rule applies to debts and obligations in his sole name. The only way you would be contractually obligated to pay any of his bills is if you're a guarantor of the debt, such as because you co-signed on a credit card or auto loan.
And remember, the executor of the decedent's estate has no control over a POD account because it never becomes part of his probate estate. But your liability as an account beneficiary can also depend on state law in some states. You might have to sign an affidavit confirming that the POD account owner did not have any outstanding debts prior to collecting the money.
Capital Gains Tax Issues
Whenever you inherit anything that appreciates in value, and you then sell or dispose of it, you can be liable for capital gains tax on the profits. This tax is levied on the difference between your basis—normally what you paid for the asset—and the sales price if it's greater and you haven't disposed of the property at a loss.
Cash is cash, so you wouldn't normally encounter this problem with a run-of-the-mill POD bank account. But other POD or transfer-on-death assets that appreciate in value, such as stocks, can generate capital gains when and if you dispose of them. Your basis in inherited assets is their value as of the date of death, not what the decedent first paid for them, which might be significantly less and result in a larger taxable gain.