Imagine you just received an inheritance. You make plans for the money and then realize you might need to pay inheritance taxes. But you don’t know if taxes are due or how much you’ll pay. In this article, we’ll explore inheritance taxes, what they are, the laws that govern them, and how to limit your tax liability so you won’t get caught off guard!
What Are Inheritance Taxes?
Inheritance taxes are also known as death duties ( March 1, 2023). Governments impose inheritance taxes on assets and properties received by beneficiaries after someone dies. Taxes are on the total value of the inheritance. And the taxes can vary depending on different reasons. One reason may include the state where the deceased lived. Another may depend on the size of the inheritance. And another may be the relationship between the deceased and the beneficiary.
The Complexity of Inheritance Taxes
Inheritance taxes can be a complex and confusing topic. If you find yourself inheriting money or property, it’s important to understand the potential tax liability and how to protect your inheritance. Consider these points.
Inheritance Taxes vs Estate Taxes
It’s important to distinguish between inheritance taxes and estate taxes. While often used interchangeably, they are different. Estate taxes are levied on the total value of a deceased person’s estate. Inheritance taxes are levied on the beneficiaries who receive specific assets or property. The key difference lies in who bears the tax burden.
The federal government does not impose an inheritance tax. This is regardless of whether you inherit cash, investments, or property. But any subsequent earnings on the inherited assets may be taxable. If the asset came from a tax-free source, like a Roth IRA, you may not owe taxes, provided you follow the IRS rules.
Some states have inheritance tax laws. As of 2023, Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania have inheritance tax laws. But Iowa will phase out inheritance taxes in 2024. And the state law depends on where the deceased lived. Not where you live. For example, you might pay taxes to Kentucky if someone left you property from there, regardless of where you live. The relationship may also decide if the beneficiary owes taxes. For example, a sibling might not owe inheritance tax, but a distant relative may.
Inherited Individual Retirement Accounts (IRA’s)
Taxes on inherited IRA’s are complex. The tax rules vary depending on your relationship with the deceased and the type of IRA. The rules impose mandatory withdrawals rather than a direct tax. The withdrawal adds to your taxable income. But the rules vary by relationship, year of death, and other reasons. Consider speaking with a tax professional or Financial Advisor to help you navigate the withdrawal rules for an inherited IRA.
Managing Inheritance Taxes
If you find yourself inheriting money, consider these tips to help manage the taxes.
Determine the Source of Your Inheritance
Your relationship with the deceased may decide your inheritance tax bill. For example, you may owe less tax for an inheritance from a sibling than from a distant relative. The decision is state dependent.
Know Exemptions and Thresholds
Not all inheritances are subject to taxes. Many states have exemptions and thresholds that decide whether you owe inheritance taxes. Typically, smaller inheritances are exempt.
Seek Professional Guidance
When your inheritance is large or complex, consider speaking with a tax professional or Financial Advisor. They can help you navigate the tax implications to ensure you’re taking the right steps.
Keep Records and Documentation
Keeping detailed records of your inheritance is important. Include documents like statements, original investments, and appraisals. The documentation will be important when you file your taxes.
Inheritance taxes are a complex and often emotionally charged topic. This article aims to help you navigate inheritance taxes with confidence to ensure you protect your finances. Understanding inheritance taxes is important to meet your tax obligation and avoid penalties. Familiarizing yourself with the basics of inheritance tax laws and seeking professional advice can help with your overall financial planning.
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These concepts were derived under current laws and regulations. Changes in the law or regulations may affect the information provided. This information is not intended to be used – and cannot be used – to avoid penalties under the Internal Revenue Code.
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Georgene Collins, RICP®, RN, PhD, MBA is a registered nurse turned Financial Advisor at Airey Financial Group. Georgene helps other nurses take control of their finances and prepare for retirement. Georgene began her career with Airey Financial Group in 2017 after retiring from 30 years in healthcare.
Georgene holds the Retirement Income Certified Professional (RICP®) designation from The American College of Financial Services. She holds health and life insurance licenses and a long-term care certificate in Indiana and Illinois. Georgene is a Registered Representative and Investment Advisor Representative and has earned the FINRA Series 63 and 65 registrations.