Undoubtedly, you want to make things as easy as possible on your heirs, from both a financial and emotional standpoint.
Strategy: Investigate the idea of using a “funeral trust.” As the name implies, you fund the trust ahead of time to help pay for future funeral costs. And a funeral trust may benefit from a special tax election. A new federal law is increasing the maximum contribution allowed for this purpose.
Here’s the whole story: A funeral trust is essentially an agreement between an individual and a funeral home, cemetery or similar entity. The individual purchaser pre-funds the designated services and/or merchandise. Pursuant to the applicable state law, the funds are held in trust during the individual’s lifetime and are paid to the funeral home or cemetery upon his or her death.
The IRS generally treats such funeral trusts as “grantor trusts” where the annual income from the trust is taxed to the grantor (i.e., the individual purchaser). Essentially, the trust income is taxable to the grantor if he or she has the right or ability to revoke the trust or has a reversionary interest in the trust assets.
Special election: Under Section 685 of the tax code, a special election for “qualified funeral trusts” may be made to avoid having the trust treated as a grantor trust. Thus, the purchaser won’t be subject to tax on the annual trust income. Instead, the trustee is liable for paying the tax, based on the in effect for estates and trusts for that particular year.
However, a purchaser cannot exceed a maximum contribution limit. If it does, the trust loses its status as a qualified funeral trust. If a funeral trust is designed to provide expenses for multiple beneficiaries (e.g., spouses), the contribution limit applies separately to each individual.
For 2008, the maximum contribution allowed was $9,000. In the past, this amount has been indexed for inflation. Under the new Hubbard Act, the dollar cap is removed.
Tip: The IRS has included funeral trusts on a list of common tax-evasion schemes, so tread carefully. See http://www.irs.gov/businesses/small/article/0,,id=106553,00.html.
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