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Inherited stock distribution issues


Dear Tax Talk,
My siblings and I are wondering what would be the best choice regarding the inheritance of stock. Should we sell the stock before we distribute the money, or distribute the stock directly to each sibling? What are the tax implications? Thanks. -- Rita

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Dear Rita,
When you inherit property such as stock, you get a step up in its cost basis to its current fair market value. The cost basis is used for determining the gain or loss on the subsequent sale of the stock.

When a person dies, his (or her) assets pass to an estate for purposes of administration such as probate until they are finally distributed to the beneficiaries, either in-kind or as a cash distribution.

An estate is a separate taxable entity during administration and requires the filing of a separate tax return (Form 1041). Dividends and other income earned during the period of administration are reported on this tax return and if tax is due, it's paid. For example, if the stocks produce $1,000 in dividend income a year, the estate will need to file a Form 1041 and pay the tax applicable to that $1,000. If the estate earns less than $600 for the year, no tax return is due. If a tax return is due, the estate should apply for a tax identification number on Form SS-4 (you can do this online) and the executor of the estate should file Form 56 to establish authority to act for the estate.

Whether the estate should sell the stock or not carries some tax implications, but you also have fiduciary responsibilities to protect the estate's assets as executor of the estate.

Since the cost of the stock became the fair market value on the date of death of the decedent, there probably will be little or no gain to pay tax on if the stock is sold. When a gain is realized, it will flow through to the beneficiaries if the proceeds are distributed to them in the same tax year as the stock is sold, and the estate will not pay tax. Loss on the sale of stock will carry forward until utilized; if not used, the loss can pass through to the beneficiaries on the final return of the estate.

The tax implications of distributing stock to a beneficiary differs, depending if he (or she) is entitled to a specific bequest or if he is a residual beneficiary. A beneficiary is entitled to a specific bequest if the will provides that that person will receive a set sum such as $5,000. If this is the case, and you distribute stock to satisfy the bequest, the estate is treated as having sold the stock and the beneficiary is treated as receiving $5,000. A residual beneficiary is a beneficiary who receives a portion of the estate. An example would be an estate that is divided equally between two siblings. Distributions to residual beneficiaries go to them at the date-of-death value, and no gain or loss is realized by the estate.

As the executor of the estate, it is your responsibility to conserve the assets of the estate for the beneficiaries. If the assets consist of stocks, then you need to consider whether they should be held or sold so as to guarantee value to the beneficiaries. For example, if the estate consists wholly of stock in one company, then you as executor need to consider the need to diversify the assets.

Internal Revenue Service Publication 559 provides helpful tax information.

-- Posted: June 16, 2004




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