Understanding Inheritance Taxes: How to Minimize the Impact
Introduction:
Receiving an inheritance can be a bittersweet experience, as it often comes with the burden of inheritance taxes. Although the federal government does not impose a tax on inheritances, some states have their own regulations in place. However, there are strategies you can employ to minimize the impact of these taxes and ensure that your loved ones receive the maximum benefit from their inheritance.
States With an Inheritance Tax:
Currently, six states charge an inheritance tax: Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. Among these states, New Jersey has the highest inheritance tax rate. Rates in other states range from 11 percent to 16 percent, with Nebraska having the highest rate at 18 percent. It’s worth noting that if the deceased lived in a state without an inheritance tax, the beneficiary will not have to pay any taxes. Conversely, if the deceased lived in a state with an inheritance tax, taxes will depend on the state where they resided.
Avoiding Inheritance Taxes:
If you find yourself in a situation where you live in a state with an inheritance tax and anticipate a significant transfer of wealth, it may be worth considering a move to a state without an inheritance tax. However, it’s crucial to make this move before receiving the inheritance to ensure eligibility for tax exemptions.
Paying the Inheritance Tax:
Not everyone who receives an inheritance will be subject to an inheritance tax. Most states exempt surviving spouses, parents, children, siblings, and other close relatives from paying this tax. Additionally, some states extend exemptions to domestic partners, grandparents, grandchildren, great-grandchildren, stepchildren, and adopted descendants.
The States That Charge an Estate Tax:
In addition to inheritance taxes, some states also charge an estate tax. The District of Columbia and twelve states impose this tax: Connecticut, Hawaii, Illinois, Maine, Maryland, Massachusetts, Minnesota, New York, Oregon, Rhode Island, Vermont, and Washington. Maryland is the only state that charges both an inheritance and estate tax. It’s important to note that estate taxes can significantly reduce the value of an inheritance.
Exemptions to an Inheritance Tax:
States that levy inheritance taxes typically have a tax exemption threshold. This exemption allows you to receive an inheritance up to a certain amount without incurring any taxes. Any amount above the exemption threshold is usually subject to taxation on a graded scale.
Giving Your Estate Away as Gifts:
If you live in a state where taxes can diminish your beneficiaries’ inheritance, you may consider giving money to your heirs as gifts to avoid these taxes. The federal government allows individuals to give gifts up to $18,000 in 2024 to as many people as they wish without affecting their lifetime gift exclusion. For couples, this amount doubles to $36,000. It’s important to note that gifts exceeding $18,000 need to be reported to the IRS, but taxes are only applicable once an individual exceeds the lifetime gift exclusion of $13.61 million in 2024.
The Annual Gift Exclusion Reverts to 2018 Levels in 2026:
It’s essential to plan ahead when utilizing gifting strategies. While the lifetime exclusion amount for gifts is currently $13.61 million, it is set to revert to its 2018 level of $5 million plus inflation at the end of 2025. By making strategic gifts and reducing your estate, you can ensure that your beneficiaries receive more from their inheritance.
Selling Inherited Property:
Inherited property can be sold, but it’s crucial to determine the fair market value (FMV) at the time of the owner’s death before proceeding with the sale. Any gain from the sale above the FMV is considered capital gains on inherited property and may be subject to taxes.
Conclusion:
Inheritance taxes can significantly impact the value of an inherited estate, but with careful planning, it is possible to minimize their impact. Understanding the specific regulations in your state and exploring strategies such as gifting and strategic estate planning can help ensure that your loved ones receive the maximum benefit from their inheritance. Consulting with an estate planner or tax consultant is crucial to navigating the complexities of inheritance tax laws and finding the best approach for your unique circumstances.
