One way that the Internal Revenue Service and the State of Ohio allow you to minimize your estate tax burden is by pre-paying for your funeral arrangements. Many funeral homes promote this as a good way to make the arrangements according to your wishes and to allow you to minimize your funeral costs by "locking in" at current funeral prices. What they may not mention is the added bonus of minimizing your estate tax burden by taking advantage of these pre-paid arrangements. Some financial counselors might argue that investing the money instead may yield a higher return than the future cost of a funeral, however, this does not account for your peace of mind and the price of a more expensive funeral that a loved one may be talked into when you die.

The Internal Revenue Service does not include the value of owing a pre-paid funeral arrangement in a decedent's gross estate. Under Internal Revenue Code (IRC) Section 2033, Property in which the Decedent had an Interest, the value of the gross estate includes all of the value of any property that the decedent had an interest at the time of his or her death. However, Internal Revenue Regulation Section (REG) 20.2033-1(b) Miscellaneous examples, talks about cemetery lots not being included in the value of the decedent's gross estate. Also, IRC Section 2053, Expenses, Indebtedness, and Taxes, allows the decedent's estate to take expenses for funerals as one of the deductions from the gross estate. REG 20.2053-2 Deduction for funeral expenses, reads in part "Such amounts for funeral expenses are allowed as deductions from a decedent's gross estate ... A reasonable expenditure for a tombstone, monument, or mausoleum, or for a burial lot, either for the decedent or his family, including a reasonable expenditure for its future care, may be deducted ... Included in funeral expenses is the cost of transportation of the person bringing the body to the place of burial." The taxpayer assistance line at our local IRS office confirmed this interpretation and the technical advisor said that any pre-paid funeral plan should be listed as merely a non-taxable notation on Schedule J of FORM 706, United States Estate Tax Return.

It is important to note that the IRS does not allow a deduction from income on a decedent's FORM 1041, United States Income Tax Return for Estates and Trusts. Publication 559, Survivors, Executors and Administrators, reads in part "Funeral expenses. Funeral expenses paid by the estate are not deductible in figuring the estate's taxable income (Form 1041). They are deductible only for determining the taxable estate for Federal estate tax purposes (Form 706)."

Similarly, Ohio Revised Code Section 5731.16, Deductions for Funeral and Administration Expense, Debts, and Mortgage Debts, allows a deduction from the value of the gross estate for funeral expenses. Pre-paid funeral plans can also be listed as a non-taxable notation on Schedule J of the Ohio Estate Tax Return.

So what does all this mean? Let's go through an example for John Doe:

John is trying to decide if he should buy a pre-paid funeral plan for $10,000. His gross estate is $700,000. Before deductions, the Federal estate tax on John's estate would be $74,000 and the Ohio estate tax would be $30,600 for a total combined estate tax of $104,600. Assuming that the cost of the same funeral would be $20,000 at the time it is needed, could there be a savings for John's survivors? By pre-paying for the funeral, John could save his survivors $5,600 after taxes. This is computed as follows:

$10,000 x 44% (combined effective Federal and Ohio Estate tax rate) = $4,400 (deduction)

$10,000 - $4,400 = $5,600 (the after tax cost of the prepaid funeral)

$20,000 x 44% = $8,800 (deduction)

$20,000 - $8,800 = $11,200 (the after tax cost of the funeral at the time of death)

$11,200 - $5,600 = $5,600 savings to John's survivors.

Similar savings would be obtained for married couples and families with estates under $650,000 (as of 1997 the Federal Estate Tax Exemption was raised from $600,000 to $675,000 in 2000 and is scheduled to be gradually raised to $1,000,000 by the year 2006) would save the expense of Ohio estate taxes. Pre-paying for your funeral could result in both peace of mind for you and significant tax savings for your loved ones.