Jim Irsay died recently, age 65. If you don’t know who Jim Irsay was, he was the owner of the Indianapolis Colts football team. His father bought the team and moved it from Baltimore. Jim inherited the franchise and ran it for most of his life.
Irsay had an estate which has been estimated at $4.8 billion, the Colts being the bulk of that at an estimated $4.4 billion. He was divorced and left his entire estate to his three daughters. This is going to be a problem for them. Under current law, everything over $14 million is subject to a federal estate tax of 40%. That means his daughters will have to come up with the money to pay a tax bill of almost $2 billion. So if they want to keep the Colts, assuming they apply the $0.4 billion of other assets to the tax bill, they are going to need to raise another $1.6 billion to pay the IRS. That could mean taking on a heavy debt load to finance the tax, or it may just force them to sell the team regardless.
At this point you might be thinking “I don’t care about this. I stopped reading the minute I saw that only everything over $14 million is taxed. I won’t be anywhere near that number, so I don’t have to worry about it.” And you may be right; chances are you will never be subject to the 40% estate tax.
But you might be subject to another tax that could approach 40% of your estate.
Income taxes do not apply to most things you inherit, but they do apply to tax-deferred assets. If my uncle dies and leaves me his house, worth $600,000, I do not have $600,000 of taxable income. My uncle already paid income tax on the money he earned, which he used to buy the house. But if my uncle dies and leaves me his IRA which is worth $600,000, then I do have that much taxable income.
This is because an IRA—or a 401(k), 403B, TSP, deferred comp, or other tax-deferred account—is subject to income tax. You do not pay tax on that money when it goes into the account. You pay it when you withdraw it from the account, presumably when you are retired. The assumption is that you will be earning less in your retirement years, so you won’t pay as much income tax on that money. But you do have to pay some tax.
And if you have money in a tax-deferred account when you die, your heirs will have to pay the income tax. How much they have to pay depends on what they do with it.
It used to be that if I inherited my uncle’s IRA, I had the option of spreading it out over my entire life expectancy. The law changed a few years ago, so that now I only have 10 years to take that money out. That still helps with the tax bill, because I can spread the withdrawals out, so instead of an extra $600,000 in one year, I would have $60,000 a year for the next 10 years. That results in a lower tax bracket.
But let us say, for the moment, that instead of rolling that inheritance into a beneficiary IRA and taking it out a bit at a time, I roll it into a regular, non-tax-deferred account. If I do that, the entire account will be treated as taxable income in one year.
And that means if I make even a modest amount of income on my own, I will be in the highest possible federal income tax bracket. At the moment, that is 37.5%. On top of that, because I will be treated as a “high earner” I will be ineligible for a lot of ordinary tax breaks. For instance, any investment income I have will be taxed for Medicare, and if I am already receiving Medicare, I will be subject to the dreaded IRMAA adjustment.
So yes, even if I am far below what James Irsay’s daughters will inherit—or even far below the less impressive but still pretty high $14 million estate tax exclusion, I could be subject to a tax of almost 40% of my estate.
There are things which you can do to reduce the tax bite on the inheritance of tax-deferred assets, including leaving some of it to charities (which pay no income tax because they are tax-exempt), using a specialized type of trust called an IRA conduit trust, or simply making sure your heirs know about the importance of rolling those accounts into a beneficiary IRA. Otherwise, your loved ones could be paying the same tax rate as the young women who now own the Indianapolis Colts.
But your heirs won’t get to sit in the owner’s box.
Kenneth Kirk is an Anchorage estate planning attorney. Nothing in this article should be taken as legal advice for a specific situation; for specific advice you should consult a professional who can take all the facts into account. Not to brag, but I also once drove to Indianapolis in the middle of the night.
