Navigating the regulations of inheritance tax can add to an already complex and stressful situation for beneficiaries. Whether or not this is your first time paying inheritance tax, knowing the latest in tax laws can make transferring your wealth and handling the details a stress-free affair.
1. Federal vs. State Taxes
In addition to federal tax, each state has various regulations regarding inheritance tax. Iowa, Kentucky, Maryland, Nebraska, New Jersey and Pennsylvania have a local inheritance tax.1 Even if you don’t live in a state that collects inheritance tax, you may not be able to receive the assets tax-free. If the owner of the bequeathed property lived in one of these six states, you could be required to pay taxes before receiving the inheritance.
However, some beneficiaries might be exempt depending on their relationship. States categorize beneficiaries into three separate classes for exemptions that include Classes A, B and C. Class A is generally described as immediate relations while classes B and C are more distant relations. Those receiving an inheritance can explore their relationship status to the giver to see if they may be eligible for additional tax exemptions.
2. Maximum Payout
As of 2021, inheritors can receive up to 11.7 million dollars exempted as a beneficiary through an estate.2 This exemption can change based on your relationship with whoever has identified you as their beneficiary. If the inheritance does go through an estate, it can potentially take many years for you to receive the assets.
3. Exemption Transfers
You could receive more than an inheritance depending on your relationship status. If you are receiving an inheritance from your spouse, you could also receive any unused tax exemptions. Your spouse may elect to pass their exemptions to you on a filed estate tax return.2 This is something you both can prepare for in advance as a way to avoid further tax implications.
Depending on the collective value of the assets, the amount you have to pay in inheritance tax will vary. However, there are deductions beneficiaries can make regarding the amount of taxes on the assets. There are areas in Form 706 from the IRS that allows for deductions including:3
- Funeral expenses
- Debts from the decedent
- Charitable gifts made during your lifetime
- Bequests to your surviving spouse
As you manage the estate of the deceased and make end-of-life preparations, beneficiaries can keep in mind the various expenses that may arise that can be put towards deductions. Tracking your expenses during this time can allow for fewer taxes being made on the inherited property.
5. Capital Gains Tax
Consequently, the tax you pay on the property and money you’ve inherited could increase even after you’ve paid the inheritance tax. Beneficiaries could possibly face additional taxes should the inherited assets increase in value and capital gains tax could be applicable if you should sell the inherited assets. The rate of capital gains tax is generally based on the accumulation of profit you make on such assets.4 Depending on your local state laws, assets such as a stock portfolio that increases in value or is sold at a higher value than when you inherited it could impact your capital gains.
You could owe less in inheritance tax than you think due to your relationship to the giver as well as the overall value and location of the property. Exploring the latest inheritance tax laws can help you avoid certain tax implications that could cause you to owe more than you should.
Award-winning CPAs and CFPs, the financial advisors at Outlook Wealth Advisors, offer a unique, holistic perspective most other firms simply cannot offer. They have assisted retirees and pre-retirees manage wealth and prepare tax-friendly retirement plans over 25 years. Email us at [email protected] or call 281-872-1515 to get started.