I received a $300,000 inheritance from my mother, which is in a separate account earning interest.
If I’m married and we file taxes jointly, our joint income taxes would have to pay for these interest earnings.
How does the interest earned affect the “separateness” of that inherited account?
Commingling Conundrum
Dear Commingling,
Your letter never mentions the words “divorce,” “split” or gives any whiff of relationship strife. I don’t wish that on you, and I’m sorry to even raise the specter.
But the letter is about the property that spouses do and don’t share — and when the lines blur.
So I checked with a matrimonial lawyer. “The easy fix would be for the spouse to have a [certified public accountant] figure out tax consequences and write a check,” said Ben Stevens, senior partner at The Stevens Law Group in Spartanburg, S.C.
In other words, determine the tax liability from the interest income and then pay it with money that’s yours and yours alone, he explained.
“That would remove any concern,” said Stevens, who is also the current president of the American Academy of Matrimonial Lawyers. It would also be a strong counter to the arguments of hiring what some people might refer to as “a very creative lawyer,” he added.
To be safe, it would be wise to pull the money for any taxes on the interest directly from the inherited account, said Paula McMillan, wealth management advisor with Stearns Financial Group in Greensboro, N.C.
Just before tapping the inherited account, write the check’s amount in a ledger and its purpose. “Create a paper trail,” McMillan said. In this particular withdrawal, take only what’s needed for taxes, she added.
McMillan advises depositing the check from the inherited account into the checking account that pays any tax bills, even if that’s a joint account. A separate check just for one bit of a tax bill could confuse the IRS or state tax agencies, McMillan noted.
But the ledger traces the money back to the inherited account if you, your spouse or anyone else needs to determine the source of tax payments related to this account.
Stevens deals with the division of marital assets and non-marital assets all the time. Gifts and inheritances meant for one particular person in a couple are “the classic example of non-marital assets,” he said.
Transmutation of separate assets
Of course, non-marital assets can turn into marital assets. That’s the divorce law concept of “transmutation,” Stevens added.
If, for example, you deposited the $300,000 into a joint account, that would turn the money from a separate asset to a marital asset. If you used a part of that money for a renovation on your jointly-held home, once again transmutation would occur.
But even without the separate payment tactic, could tax payments from a commingled account convert the inherited account into shared property?
“In South Carolina, I think the answer would be no,” said Stevens. That thinking could generally apply elsewhere, but he said it’s best to check with an expert on your state-specific rules.
Cash investments and savings accounts became more alluring as interest rates climbed in 2022 and 2023, but they are taxed as ordinary income and not as a capital gain with a preferential tax rate.
Married couples filing separate income-tax returns typically sacrifice the tax breaks and money advantages of a joint return, McMillan said. “Unless it’s contentious or some other reason, you don’t come out ahead,” she said.
Maybe the twists of tax and matrimonial law sound involved. But that’s the easy part. Proceed with caution on how you discuss this and handle it with your spouse.
Claims on money and family dynamics are a powerful concoction that can sour easily.
“There’s money and all of the sudden, it’s a bloodbath. It’s just awful to watch,” Stevens said. So proceed with care.
Stevens regularly meets with people who aren’t readying a split but just want to know the ‘what if’s. “It’s never too early to ask those questions, because they can save heartache, headache and money down the road,” he said.
Got a tax question? Write me at akeshner@marketwatch.com.
Thanks for reading. I want to help you think more broadly about the issues that affect your taxes. I’m not offering tax advice, just an attempt to look at what the swirl of tax rules and economic conditions could mean for your wallet.
