Adopting an adult to save on inheritance taxes
Inflation has boosted many estates into a range where federal and state taxes on assets conveyed at death are significant. There is little one can do about federal estate taxes which is not generally well known. But state inheritance taxes may be reduced for some people if they act quickly.
Not all states impose a tax on inheritances received by heirs. The inheritance tax differs from the estate tax because the heir pays the tax according to how much he receives and his relationship to the decedent. Nineteen states use the estate-tax system rather than the inheritance tax.
Inheritance-tax systems typically divide heirs into at least three classes according to the relationship between heir and decedent. But states' regulations differ widely, and tax rates and exemptions not only vary but have been changed recently. The three classes of heirs in Washington State, a fairly typical inheritance-tax state, are:
Class A -- Spouse, children, lineal descendants of children, adopted children (subject to some limits), lineal descendants of adoptees, stepchildren, lineal descendants of stepchildren, and sons- or daughter,-in law.
Class B -- Brother, sister, and lineal descendants of brother and sister.
Class C -- All others.
Inheritance taxes up to $100,000 are exempt in Washington for a spouse and minor children. Above $100,000 the rate increases progressively from 1 to 10 percent. An exemption of $10,000 applies to other Class A heirs. But a Class C recipient is taxed from the first dollar, with no allowable exemption. Further, rates begin at 10 percent and extend to 25 percent on all inheritances above $ 100,000.
Similar differences apply to heirs in 30 states and the District of Columbia. Single people or couples with no direct lineal descendants are faced with the prospect of their friends, cousins, or nephews and nieces having to pay more taxes than if their inheritances were being received by close relatives. The difference in inheritance taxes on a $100,000 bequest to a nonpreferred (Class C) heir and a Class A heir in Washington could be around $15,000, and the difference escalates as inherited amounts increase. On a bequest of $1 million, the difference (not the tax) could be as much as $155,000.
Charles Moriarty Jr., a lawyer in Seattle, has been using a legal adult adoption procedure for about 10 years to convert a Class C heir into a Class A heir. The adoption procedure is simple, takes only a few minutes in court, is private, and costs little. In some cases it makes more sense to adopt a potential heir's parents. Otherwise, an adult adoptee could be cut off from his normal parents' rights. Weird relationships could develop, but the potential tax savings can be overriding for persons without direct descendants.
Mr. Moriarty has written a book detailing the benefits and potential pitfalls to avoid in adopting adults to reduce taxes. Its title is "Adopt Your Way to Inheritance and Gift Tax Savings" (Writing Works, Box 752, Mercer Island, Wash. 98040, $12.95 plus $1 postage). The Writing Works also publishes the capital-withdrawal charts noted in earlier "Moneywise" columns.
But suppose you live in a state where estate taxes are levied instead of inheritance taxes, or adult adoption is not allowed? You could move. Mr. Moriarty has included a summary of the tax provisions for each of the states in which adult adoption is feasible and could reduce taxes. When people retire and move, one consideration could be the inheritance-tax laws of their new state. One's residence state determines how gifts and inheritances will be taxed -- not the state where heirs live.