A Payable on Death or POD account also known as a Totten Trust account is a bank account that offers the account holder the option of choosing a beneficiary who will be able to receive the balance in the account after the death of the account owner. Transferring property through the POD account can be an easy process since you do not have to go through the probate process to transfer the asset to the beneficiary of your choice.
Yet there is a usual query on the accounts of POD regarding its taxability. Is it mandatory to report and pay taxes on a POD account when the prior holder is alive or on the death of the beneficiary? In the following subtopics, we shall look at the aspects of tax concerning POD accounts.
This is so that even if the original owner of the POD account is alive, it will have to be like any other ordinary bank account as far as taxes are concerned. Any interest earned in the account is taxed in the same way:
- If the account earns $10 or more in the calendar year in interest the bank will provide you with Form 1099-INT for the interest received. All these generated from this bank interest must be declared on the tax return and the tax paid on the same.
- The interest is fully taxable under ordinary federal and state income tax rates relying on your overall gross income every year.
Therefore, while the original owner is alive, a POD account has no special status or treatment in terms of taxes. The owner must report interest earned on the account in a given year and pay taxes on the amount. It is important to note that this account is not motivated to be free from income tax merely because it contains a POD designation.
If a POD account holder dies, the treatment of the assets drastically shifts even if it initially belonged to another person. At this stage, the account value transfers to the named beneficiary. This transfer may not occur through the probate process.
The good news is that if you are the beneficiary of a POD account, you are not required to pay federal or state income taxes for the money you receive. This is why the POD account receives what is known as a ‘step-up’ on a tax basis since the transfer happens at the time of the account owner’s death. This means that the cost basis of the amount to be accounted for is adjusted to the date of death value.
Therefore, upon the transfer of the property to the inheriting beneficiary, the new basis amount would be free of taxes. However, interest credited to the account, even if it grew significantly compared to the original deposits, is untaxed. Thus, the beneficiary can withdraw the full balance with no income tax bill at the end of the annuity payment.
Exemptions may apply where the new owner then earns further interest on the POD funds that they receive as a result. At that point:
- It is again wanted that interest would start getting taxable every year in the future at the rate of income tax of the beneficiary.
- If the beneficiary dies and the remaining POD account is left to another inheritor, then the latter would also receive another step-up on a basis.
In summary, it is vital to understand that inheriting a POD account does not itself generate federal or state income tax. Only if the interest is earned after the owner’s death is it subject to tax in the future.
While federal and state income taxes usually don’t apply to Payable on Death accounts, you should still be aware of other taxes that could come into play:
Estate Taxes
For rich people, it means that they may end up with their estates having values more than the federal or state estate tax exclusion figures once they inherit the POD account. This could result in massive estate taxes even though income taxes have been saved. Some states deem property tax as an agent of state estate tax while others do not have specific rules regarding the state estate tax.
Gift Taxes
However, it would be interesting to note that in some circumstances funding an initial POD Accounts Payable might be regarded as a taxable gift if funded, perhaps, irrevocably. The specialists in taxation suggest that if gift taxes are an issue, then proper coordination should be maintained.
State Inheritance Taxes
Some states only allow POD transfer recipients to pay inheritance taxes while the remaining states do not. For instance, those in Iowa, Kentucky, Maryland, Nebraska, New Jersey, or Pennsylvania should consider the specifics of state inheritance tax.
The conclusion that can be made is that while income tax does not apply to POA/POD, other taxes may lead to a decrease in the final amount received in certain cases. One of the key features of successful planning is that it is necessary, especially for large accounts.
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