SmartAsset: What You Need to Know About Inheritance Tax

SmartAsset: What You Need to Know About Inheritance Tax

There comes a time in all of our lives when we have to say goodbye to a family member or friend. If you were close with the person who passed away, you might discover that they’ve left you something in their last will and testament. Before you officially take over your mother’s house or claim her jewelry, there’s one more thing you might have to worry about: an inheritance tax on your new assets.

A financial advisor can help you minimize inheritance tax by creating an estate plan for you and your family. Find a financial advisor today.

What Is an Inheritance Tax?

An inheritance tax requires beneficiaries to pay taxes on assets and properties they’ve inherited from someone who has died. Sometimes an inheritance tax is used interchangeably with the term “estate tax.” Both are forms of so-called death taxes, but in fact they’re two different types of taxes.

By definition, estate taxes are taxes on someone’s right to transfer ownership of their entire estate to their loved ones when they die. The most important factor here is property value.

If the value of the assets being transferred is higher than the federal estate tax exemption (which is $12.06 million for tax year 2022 and $12.92 million for tax year 2023), the property can be subject to federal estate tax. States have their own exemption thresholds as well. Estate taxes are deducted from the property that’s being passed on before a beneficiary claims it. However, President Joe Biden has proposed eliminating the “stepped-up basis,” a provision that resets the value of inherited property to its current market value when its original owner dies.

In contrast, with inheritance taxes the focus is usually on who the heir is. And while it’s possible to owe estate taxes at the state and/or federal level, inheritance taxes are only collected by states.

Only six states impose an inheritance tax. So if you’re inheriting something from a person who lived in any of the following places, your inheritance might be subject to state taxes:

  • Maryland

  • Nebraska

  • Kentucky

  • New Jersey

  • Pennsylvania

  • Iowa

Even if you’re an heir and you live in any of these states, you’re off the hook if the benefactor who left you the inheritance lived in one of the other 44 states.

Who Has to Pay an Inheritance Tax?

SmartAsset: What You Need to Know About Inheritance Tax

SmartAsset: What You Need to Know About Inheritance Tax

As you can see, there are only six states with inheritance taxes. Overall, inheritance tax rates vary based on the beneficiary’s relationship to the deceased person.

Spouses are automatically exempt from inheritance taxes. That means that if your husband or wife passes away and leaves you a condo, you won’t have to pay an inheritance tax at all even if the property is located in one of the states mentioned above. Since the Supreme Court’s ruling, the same rule applies to same-sex spouses.

Children and grandchildren who receive an inheritance aren’t taxed either if the deceased person lived in any of these four states: New Jersey, Kentucky, Iowa or Maryland. The bad news then is that all other relatives – and kids and grandkids receiving property from Pennsylvania and Nebraska – may have to pay up.

How Much Is the Inheritance Tax?

Here’s a breakdown of each state’s inheritance tax rate ranges:

Rates and tax laws can change from one year to the next. For example, Indiana once had an inheritance tax, but it was removed from state law in 2013.

Avoiding Inheritance Tax

SmartAsset: What You Need to Know About Inheritance Tax

SmartAsset: What You Need to Know About Inheritance Tax

Besides getting married or convincing your family members to move, there are other steps you can take if you’re trying to figure out how to avoid an inheritance tax.

One option is convincing your relative to give you a portion of your inheritance money every year as a gift. In 2023, anyone can give another person up to $17,000 within the year and avoid paying a gift tax. Married couples who have joint ownership of property can give away up to $34,000.

As an alternative strategy, you could ask your loved one to set up a revocable trust. That way, they can set aside their property and investments for you and their other beneficiaries without having to be concerned with inheritance taxes.

When a trust is revocable, whoever put their assets into it can take them back out if necessary. On the flip side, once something goes into an irrevocable trust, it remains in there permanently until the person who established the trust dies and everything is handed over to the heirs.

Bottom Line

When you’ve lost someone you love, the last thing you want to think about is paying taxes on the items you’ve inherited. That’s why if your relatives live in a state with an inheritance tax, it might be a good idea to talk to them about trusts and estate planning as soon as possible. There may also be income taxes that you have to pay if you’ve inherited an account like an IRA or a 401(k).

Tips for Estate Planning

  • Estate planning can be complicated, so it pays to be prepared. A financial advisor can be a solid resource to lean on. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.

  • Estate planning can be complex, and that’s especially true if you’re someone with significant wealth. To make sure you have everything you need, read up on the essential estate planning tools for wealthy investors.

  • If you want your beneficiaries to avoid a potentially long and costly probate process, consider creating a revocable living trust. This estate planning tool could give you the flexibility that you cannot get from other trusts or wills.

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Source: finance.yahoo.com