To Probate or Not to Probate? That is the Question.

Wendy Denton Heleen specializes in all matters relating to planning and dealing with incapacity and death, including charitable planning and estate and trust documents.  She advises her clients in regard to probate and non-probate matters, beneficiary designations and planning to minimize income, gift, Federal estate and state inheritance tax. About Wendy

When I receive a telephone call informing me that a loved one has passed away, one of the first questions I am inevitably asked is: “What do I do with his/her will?”  After the caller (“Caller”) and I discuss and explore ownership of the deceased loved one’s assets, Caller is surprised to learn that my answer to this question is often “Nothing.”  For the rest of this soliloquy, more appropriately a monologue, I will refer to the deceased loved one as “Decedent.”

In the administration of Decedent’s assets after death, as well as in the planning for disposition of a living person’s assets prior to death, it is critical to determine which assets fall into the category of “probate” and which assets fall into the category of “non-probate”. 


WHAT IS PROBATE?

Black’s Law Dictionary defines probate as: “the act or process of proving a will.  The proof before an ordinary, surrogate, register, or other duly authorized person that a document produced before him for official recognition and registration, and alleged to be the last will and testament of a certain deceased person, is such in reality.” Think of “probate” as the process whereby a selected representative - either an Executor, if there is a will; or an Administrator, if there is no will –is granted the authority to deal with assets that are owned solely in Decedent’s name that do not transfer directly by (a) operation of law; or (b) beneficiary designation.  

If, in my discussion with Caller, we determine that Decedent owned assets in his/her own name that do not transfer directly by operation of law or by beneficiary designation, we must complete paperwork, produce the original will and a death certificate, and have the named executor sworn in by the Register of Wills of the County in which Decedent was domiciled. The executor will then receive a certificate of grant of letters and will be issued short certificates evidencing the executor’s appointment.  I often describe the short certificate granted to the executor as a Willy Wonka-like “Golden Ticket”. The short certificate, together with Decedent’s death certificate, should allow the executor to step into the shoes of Decedent to make decisions and give directions regarding assets in Decedent’s own name.   Typical probate assets include: 

• Real estate owned solely by Decedent (or sometimes held jointly with a predeceased spouse) or held with another person as joint tenants in common. 

• US Savings bonds titled in Decedent’s own name; i.e., without somebody else’s name as “and” or “or” owner; and without being designated as “POD” (Payable On Death) to a living person or existing charitable organization. 

•  Any account titled in Decedent’s own name, such as checking, savings, CDs, and non-IRA brokerage accounts (sometimes referred to by brokers as “taxable investment accounts”). 

• Tangible Personal Property owned by Decedent such as a car, boat, jewelry, or artwork.

The executor named in the will is charged with collecting and distributing probate assets in accordance with Pennsylvania Law and Decedent’s will.


NON-PROBATE ASSETS

Many assets that people own are known as “non-probate” assets, meaning that it is not necessary to look at Decedent’s will to determine to whom those assets are to be distributed upon Decedent’s death.   Non-probate assets include assets that pass at death (1) by operation of law/based on title; and (2) by beneficiary designation.


OPERATION OF LAW/BASED ON TITLE

Examples of assets that pass at death by operation of law/based on title include:

• A car registered/titled to Decedent and his wife or another person. 

• Real estate owned jointly by Decedent and another person as joint tenants with rights of survivorship. 

• A bank account owned jointly by Decedent and another person. 

• A CD owned by Decedent and titled “In Trust For” his nephew. 

• US savings bonds owned by Decedent and titled “POD” to his niece.  “POD” stands for “Payable On Death”. 

• A Non-IRA brokerage account (a taxable investment account) that is owned by Decedent and titled “TOD” to his children equally upon Decedent’s death. “TOD” titling for a taxable brokerage account is equivalent to “POD” titling for a savings bond.  “TOD” stands for “Transfer  On Death.”

• Assets owned by Decedent’s Revocable Trust at death.


BENEFICIARY DESIGNATIONS

What’s in a Name?

Non-probate assets also include assets that pass by beneficiary designation upon death.  Examples of assets that typically pass by beneficiary designation include: 

• Life insurance policies.

• Annuities.

• IRA’s.

• 401(k)’s.

• 403(b)’s and other income tax deferred benefits.

Note that a typical non-probate asset can, however, be paid to the probate estate, either intentionally by naming the “estate” as the beneficiary, or unintentionally, if no beneficiary is named at all, or if the named beneficiary dies before Decedent and no contingent beneficiary is named.


WHY PROBATE IS OFTENTIMES UNNECESSARY

The probate process is often unnecessary when Decedent dies because all of Decedent’s assets are held in non-probate form.  For example, often the Caller being informed that “nothing” needs to be done with Decedent’s Will is the surviving spouse.  Lots of married couples own all of their assets in non-probate form: their house and non-IRA bank and investment accounts are held jointly in both of their names, and the surviving spouse is the named beneficiary of life insurance policies, IRAs, 401(k), and any annuities owned by Decedent. In this situation, no Executor is needed to transfer assets to the surviving spouse.  Any jointly held assets will automatically become the surviving spouse’s sole property, and the survivor can collect the life insurance, IRAs, 401(k), and annuities payable to him/her.  Yes, there will be paperwork for the surviving spouse to complete, and perhaps some hoops that the surviving spouse will need to jump through to transfer all of the assets into his/her own name, but a short certificate that is issued after a will has been subject to probate will not be required for the surviving spouse to make these transfers.


THE QUALITY OF MERCY IS NOT STRAINED, BUT THE TAX MAN SHOWS NO MERCY

In the situation described above, if Caller is the surviving spouse of Decedent, there will be no Pennsylvania inheritance taxes to pay because the rate of PA inheritance tax between spouses is 0%.  A PA inheritance tax return is required to be filed, however.  Although jointly held bank and brokerage accounts between spouses and life insurance, regardless of the beneficiary, are exempt assets for PA inheritance tax purposes, distributions to a surviving spouse from Decedent’s IRA, 401(k), annuities, etc., are taxable assets that must be reported, even though the rate of tax is 0%.   


GIVE THE DEVIL HIS DUE

Pennsylvania inheritance tax will be owed if we change our assumptions, however. Let’s suppose that Caller is Decedent’s only daughter and that Decedent was her Mother. Husband/Father died 10 years ago.  When Husband/Father died, Mother and Daughter removed Husband/Father’s name from all of the assets and substituted Daughter’s name.  The Non-IRA and bank accounts are now titled jointly “Mother and Daughter”; and Daughter is the named beneficiary of life insurance policies, IRA’s, 401(k), and annuities owned by Decedent/Mother.   First question:  Is probate required?  NO.  As in the previous example with spouses, all of the jointly held assets will automatically transfer to Daughter and Daughter can collect the life insurance, IRA’s, 401(k), and annuities after completing appropriate paperwork.  A short certificate will not be required for Daughter to title any of the assets into her name.

Second question: Will Pennsylvania inheritance tax have to be paid?  YES.  Avoiding probate does not mean avoiding Pennsylvania inheritance tax.  If you remember nothing else, remember this:  The Pennsylvania inheritance tax rules and the Pennsylvania probate requirements are not the same; whether assets are probate or non-probate is irrelevant for PA inheritance tax purposes.   What is relevant for PA inheritance tax purposes is: (1) To whom are the assets being transferred or paid; and (2) Which assets are being transferred or paid?


TO WHOM ARE THE ASSETS BEING TRANSFERRED?

Decedent’s spouse, as well as charities, are taxed at 0% for PA inheritance tax purposes.  Lineal descendants, such as children and grandchildren, are taxed at 4.5%; siblings are taxed at 12%; and “all others” -- nieces/nephews, unmarried partners, friends, Romans, countrymen -- are taxed at 15%.


WHAT ASSETS ARE BEING TRANSFERRED?

Taxability will also depend on what specific assets are being transferred.  Life insurance is an exempt asset for PA inheritance tax purposes, no matter the amount or who the beneficiary is.  However, an investment annuity sold by an insurance company is a taxable asset.  Most assets are taxable for PA inheritance tax purposes.  A jointly held account, however, may be taxed at less than 100%, based on Decedent’s proportionate ownership.

In the example of Decedent/Mother and Daughter, although Daughter does not need to probate Mother’s will, Daughter will owe PA inheritance tax at 4.5% on one-half of the balance in the joint accounts, assuming that the accounts have been jointly titled for at least one year prior to Decedent/Mother’s death.  PA inheritance tax at 4.5% will also be paid on the Daughter’s receipt of the IRAs, the 401(k), and the annuities.  Don’t forget, too, that Daughter will also have to pay income tax when she takes distributions from the IRAs and 401(k) and perhaps also on some of the annuity proceeds.  “Is this a dagger which I see before me? Double taxation?” you ask.   In a word, Yes.

When assets are being transferred upon Decedent’s death to somebody other than the spouse or charity, it is important to keep in mind that the probate estate and the taxable estate are two very different “plays”. Often there can be few (or no) probate assets and no reason to probate a will, but there may still be significant assets in the non-probate estate requiring the payment of PA inheritance tax and the filing of a PA inheritance tax return.


IS IT ALWAYS ADVISABLE TO AVOID PROBATE? 

Sometimes in the planning process I discover that a client has structured his/her assets and beneficiary designations so that ALL of the assets will pass in non-probate form at his/her death. For example, let’s hypothesize that my client is an unmarried, childless male who has three nieces.  His assets are structured like this: 

• $50,000 in checking and savings accounts that are held “In Trust For” Niece1;  

• $50,000 in a life insurance policy payable to Niece2;  

• $50,000 in an IRA in which Niece3 is named as beneficiary;  

• $150,000 in a Non-IRA brokerage account that has a “TOD” beneficiary for all three nieces, equally.

There is also a will leaving his probate estate (of which there is none) to the Salvation Army, and Niece1 is named as executor in the Will.

All’s well that ends well, but this does not end well. 

A few problems are created here: First, without any money flowing to his “estate”, how is Niece1, named executor in the will, going to pay his last bills, funeral expenses, and income taxes due at his death? Without a pot of money labeled the “estate,” Niece1, if she voluntarily takes on this responsibility, is going to have to work with the other two nieces to create a source of funds in which to pay the typical estate bills. Each niece will need to make a contribution to this fund from the assets she receives directly as beneficiary or joint owner.

The second problem is that the Salvation Army gets nothing as there is no probate estate.

The third problem is what may appear to be “equal” in the client’s mind will have different PA inheritance tax and income tax implications for the three nieces.  Niece2 is the lucky one.  She will pay no PA inheritance tax and no income tax on the receipt of the $50,000 of life insurance she receives.  Niece3 is the unlucky one. She will have to pay both PA inheritance tax at 15%, plus income tax at her marginal rate, on her receipt of the $50,000 IRA.  Niece1 will have PA inheritance tax liability at 15% on the $50,000 of deposit accounts she receives, but no income tax obligation. 

In summary, from an estate administration viewpoint, it is not always necessary to probate a will or open a probate estate when a loved one dies, but non-probate does not equal non-taxable for PA inheritance tax purposes.  From an estate planning perspective, holding all of your assets in non-probate form, thereby rendering your will irrelevant at your death, may result in your estate planning goals being thwarted and/or in unfairness among beneficiaries.  The attorneys in GRB’s estate planning and administration group can help you examine these issues from both the estate planning and the estate administration perspectives. This is certainly not much ado about nothing.