Monday, December 26, 2016

Avoid Inheritance Taxes in Iowa? Adopt that Nephew!

Adoption can be a wonderful thing.  My niece, in this picture, is adopted and she is a wonderful addition to our family.  However, adoption can have some funky applications in the estate planning world.  A recent ruling from the Iowa Supreme Court was interesting on a couple of issues involving an adoption:
  1. To avoid paying inheritance taxes for a bequest to a non-lineal descendant, a nephew was adopted by his aunt.
  2. Even though he was adopted by his aunt, the son's biological mother was still able to include an inheritance for her son.
The first point is not all that unusual and I have advised clients of this very option.  Basically, whether you are adopted or biological, as a child in Iowa, you do not pay any inheritance tax when you inherit from your parents.  But, if you are a nephew, cousin, friend (basically a non-lineal descendant) there is an inheritance tax owed on an inheritance based on this table.  So, if reducing a tax bill is worth changing your heritage, you can be adopted by someone (even though you are an adult) and escape that pesky Iowa inheritance tax.  So, whether it is a friend, nephew/niece, cousin, attorney...stop by that friendly adoption attorney's office and do your tax planning as you enlarge your family.  Many clients find this tax plan "amusing" and don't take that step.  However, here is a clear example demonstrating its real-life application.

The second point is for a little more on the advanced side.  One of the trade-offs of getting adopted is that once you are adopted, you are normally cut-off from adopting from your biological side.  So, if your rich aunt adopts you, and then the next month your mother wins the lottery and dies from a heart attack, you don't get to share in the lottery winnings as you are no longer your mother's child.  (You are your aunt's child, essentially, and you can only have one set of parents.  Mom becomes your aunt and your aunt becomes your mom.)

However, the Iowa Supreme Court made the notation that the biological parent in this case specifically named the (adopted) child and thus that specific naming of the child was enough to counter the change in status from the adoption.  For example, if the biological parent had said "I leave my millions equally to my children", then the adopted son would not have received the inheritance from biological mom.  But, since biological parent said "I leave my estate to my wonderful son Matthew" the specific naming of that biological child was enough to "override" the disinheritance by the adoption.  The court didn't mention anything about it, but I would assume that the inheritance from the biological parent was subject to inheritance tax as technically her biological son was now her nephew.  You can't win 'em all, I guess.

Moral of the story: You can have your cake and eat it, too.

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