Planning for Taxes on Inheritance

January 4, 2017

taxes on inheritanceTaxes on inheritance are imposed on property received from someone else’s estate after their death.  The federal government does not impose an inheritance tax.  Instead, inheritance taxes are imposed at the state level only. But, not all states impose an inheritance tax.  In fact, only a few states have continued to impose the tax. With the disappearance of taxes on inheritance, the term has become synonymous with estate tax.  If you live in a state that imposes an inheritance tax, or own property in a state that imposes the tax, inheritance tax planning is something you still need to consider.  Here is what you should know.

How inheritance taxes are calculated

The amount of taxes on inheritance owed depends on the property and the on the class of beneficiary. For example, surviving spouses and lineal heirs (children and grandchildren) are usually taxed at a lower tax rate.  In some cases, those heirs may be completely exempt from taxes.  More distant relatives and heirs who are not relatives, often referred to as collateral heirs, are typically taxed at a higher rate.

How inheritance tax is different from estate tax

The first distinction between taxes on inheritance and estate taxes is the fact that the inheritance tax is only imposed on the state level.   That said, some states also impose an estate tax, as well.  Another difference is the estate tax is owed by the estate of the person leaving the property, not the beneficiary who receives it.  In other words, the key difference between an estate tax and an inheritance is who is actually responsible for paying the tax.

How does the estate tax work?

The estate tax is a tax imposed on your right to transfer property to others at your death. The estate tax is calculated by first making an inventory of every property interest you own at the time of your death.  The total value of all of these assets is considered your "Gross Estate." Property that is usually included in your gross estate includes cash and securities, real estate, insurance proceeds, trusts, annuities, and business interests, just to name a few.  After required deductions are added to the equation that value is known as your "Taxable Estate."  The estate tax is then assessed on the net amount.

The first step is to find out what you will receive

Before you can successfully plan, you need to know, at least in general terms, what type of inheritance you will be receiving. For example, if you are inheriting from a parent, then you should obtain a list of assets and a copy of your parent's will, if there is one. That way you can get at least a rough estimate of the size of the estate and what your share will be.  Depending on the size of the inheritance, you will need to consider how to modify your own financial planning strategies.

Incorporating your inherited assets into your own

Exactly how you should integrate inherited assets into your own finances depends on several factors, including the nature of the assets you inherit, the financial and estate planning strategies your parent may have used, and your own financial situation. Again, if you receive government benefits of any kind, your eligibility for which are dependent on your financial resources, you will need specific inheritance planning to protect that inheritance as well as your benefits.

Determining how to handle certain assets

Depending on the nature of the assets you expect to inherit, there are certain actions you may need to take sooner, rather than later. For instance, if you wait too long to sell an asset you inherited, you could increase the chances of suffering unfavorable tax consequences.  If you are inheriting a retirement account, you need to have a plan as to how you will withdraw those retirement funds.  Being aware of all of your options is important when creating an inheritance plan, especially if your goal is to reduce your tax penalties as much as possible.

Deciding whether to disclaim or reject an inheritance

Once again, if you receive income-based government benefits, receiving a significant amount of income from an inheritance could put your eligibility for those benefits in jeopardy. If inheritance planning will not provide the protections you need, or the risk is not worth the value of the inheritance, you may want to consider rejecting it.  Many people do not realize you can reject an inheritance and there are situations where that may be the best course of action.
It is important to note that rejecting or disclaiming an inheritance requires more than simply telling the executor you do not want the money or property. There are specific laws that dictate how you can reject an inheritance.  If order to be sure that you never become the legal owner of the property, there are very specific steps that need to be followed.
Attend a FREE Webinar today!  If you have questions regarding taxes on inheritance, or any other inheritance planning issues, please contact the attorneys at Anderson, Dorn & Rader, Ltd. for a consultation, either online or by calling us at (775) 823-9455.

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