My brother, single, never married, no children, a 56 year old postal worker with several medical issues and related unpaid bills and a home with a mortgage, but very little liquid (cash) assets, died. His life insurance policies and Thrift Savings Plan at work have no designated beneficiaries. Under New Jersey intestate rules, four siblings ages 58 to 70 are the Class 3 beneficiaries.
Life insurance and a large 401K balance pass to the estate. The life insurance proceeds payable to the estate total approximately $40K, but the New Jersey inheritance tax alone calculated on the value of all assets in the estate, including the 401K, amount to approximately $70K.
Issue – Estate liquid assets are insufficient to pay inheritance tax and remaining unpaid medical and other debts. In fact, with insufficient cash assets at death, even the funeral and burial expenses were funded by the siblings directly in expectation that the amounts would be reimbursed to them when the estate finally received liquid funds.
Upon receipt of the 401K lump sum distribution into the estate bank account, can those funds be used to pay the inheritance tax and other estate unpaid debts, including the funeral and burial expenses? And if that cash is used to satisfy estate inheritance tax and other debts before distributing to sibling beneficiaries, then what value should be shown on a K1 reported to the siblings upon distribution – only the net amount each received after paying all debts; or the full amount of the 401K lump sum, divided among the four beneficiaries? If the former, then it is as if the income tax on the portion of the lump sum distribution passed tax free to pay off debts of the deceased, which seems like the IRS would object.
Alternatively, is it possible for the Estate to file an income tax return paying the income tax on the lump sum distribution directly, so that the net proceeds of the final estate distribution to the heirs then would pass tax free to them?