Handling Taxes on Inherited I Bonds from a trust?

[Zona]

My FIL recently passed away. DH and his brother are co-executors and this is everyone's first time dealing with an estate. Luckily the brothers work well together, and the two of them are also the primary 50-50 beneficiaries of the estate (a couple of 10K bequests to grandkids, etc but the remainder split evenly). FIL really did his best to title every asset in the trust or with his trust as a beneficiary so that it could be distributed easily. The one-off bequests can be handled with cash that was in the bank accounts but there is a question of how best to distribute some I bonds between the 2 brothers.

FIL had a good amount in older paper I bonds. Some of these bonds were co-titled with FIL & his Trust (ie "John Doe OR John Doe Trust") while others were titled "John Doe POD to John Doe Trust". These I bonds are issues from the early 2000s with a 2-3% fixed component and have accrued nearly $80,000 in interest over the past couple decades. There are 2 physical paper bond issues for each date/denomination so the bonds can literally be split equally. The bonds are about 7-8 years away from maturity and taxes have not yet been paid on interest.

Ideally, DH and his brother would rather split them evenly and as trustees & beneficiaries of the trust they would reissue the bonds into their own names so that they can either keep them until maturity or spread out redemptions over the next several years in their own respective tax brackets rather than redeeming/cashing them all this year through the trust and possibly owing income tax at estate income rates. Is this a viable option -- if the bonds are retitled/reissued and not redeemed, does the estate basically bypass paying taxes on them and pass the tax liability for all of the interest onto the new owners? Is this allowed, or is it required that the estate pay the tax on interest up until FILs death even if the bonds aren't redeemed?

Thanks in advance for any guidance or advice. DH is just a few weeks into this process, has a NOLO Executor book from the library and is doing his best but honestly is a bit stressed. Even though FIL did his best to plan correctly, there is still quite a bit of complexity. So over the next coming months you may see more "estate" questions from me. We'll get a lawyer or accountant involved if needed but I just wondered if anyone here had already dealt with this situation. Thanks!

 

[GrayHare]

Yes, if the bonds are distributed as you propose, taxation of their accumulated interest can be delayed under the beneficiary redeems the bonds.

Note there is a unique tax-reduction capability of savings bonds. The executor has the choice to redeem some/all bonds with the tax liability being assigned to the decedent's final tax return (hmm, or is it to the estate's tax return?). You might check on that because one of those returns may have sufficient deductions to offset the tax on that interest. Proper handling can make at least some redeemed bonds effectively tax free.

 

[Texas Proud]

Just me, and I did not look it up as it might have a special tax code, but income after death is on the estate return... I would not want to cash them in as it would either trigger taxes to the estate income tax return or the kids...

Again, just from the little I know... I think you have to transfer them into a Treasury Direct account now... no more paper bonds...

The savings bonds I have were POD with my name so I did not transfer them... I just send them in with the correct paperwork and a copy of the death certificate...

 

[GrayHare]

I checked the "Savings Bond Advisor" book by Tom Adams, worth reading if you have lots in savings bonds. It says that yes, the executor can choose to pay the deferred income taxes on bond interest on the decedent's tax return, not the estate's return. That can be a wise move if the decedent had significant deductions, such as medical expenses, shortly prior to death because it can reduce or eliminate the taxes on bond interest. AFAIK, savings bonds are the only asset with this option.

 

[Zona]

I checked the "Savings Bond Advisor" book by Tom Adams, worth reading if you have lots in savings bonds. It says that yes, the executor can choose to pay the deferred income taxes on bond interest on the decedent's tax return, not the estate's return.

Thanks for the replies. I will take a look at the book you recommend and DH can consider the option of paying taxes on the decedent's tax return. DH and I are retired and have a lot of control over our taxable income in any given year, so taking on the I bonds intact would be fine for us -- we could parse out the redemptions/interest income and do smaller Roth conversions in those years. But BIL and SIL are still working so adding large unplanned income when the I bonds mature or are redeemed would probably push them into the highest bracket. I would guess they'd rather have the decedent redeem & pay taxes on these, if that's allowed. Thanks for the info.

 

[I am He]

My Dad did his relative's taxes and used the final year's tax return. Then my Dad passed. We got a nasty-gram a year later from the IRS about taxes due on the estate so I sifted through the papers. Once I showed that the interest was paid on that prior return, all was understood and good to go.