We often build wealth and an estate in our lifetimes in hopes that, when we pass on, it can go to our loved ones and provide for them. It’s a kind of final gift to those we leave behind. Therefore, it can often be frustrating when the government takes some of this gift for itself. It’s important to understand the potential taxation that the transfer of your estate may be subject to so that you can plan accordingly.

State Inheritance Taxes

An inheritance tax is a tax that is paid by the individuals who are inheriting the property of the deceased. The rate and amount of taxation will depend on the property inherited. Obviously, the more property that one inherits, the greater the tax one will owe on that property. This can sometimes mean needing to sell the property, such as with real estate, as the inheritor will owe taxes on the value of the property but may not have the cash on hand to cover it. As of 2023, only a handful of states still have a property tax. Iowa, Kentucky, Maryland, New Jersey, and Pennsylvania all have inheritance taxes, but the laws do differ slightly in each state. If you are either inheriting something from an estate based in one of those states, or you own assets in one yourself, then you should talk to a tax professional about how to handle your situation.

Federal Inheritance Taxes

There is no federal inheritance tax as of 2023. However, there are a couple of kinds of federal taxation that are still worth considering during the inheritance process. One is the capital gains tax, which could be a factor if or when someone you’ve given property to through your estate decides to sell that property. They may be subject to capital gains taxes on any increase in value that the property experienced since they inherited it.

Another tax worth consideration is the federal estate tax, which applies to all estates with a value of $12.92 million or greater. The rates for this tax increase progressively with the size of the estate, so the larger the estate, the greater the tax burden. The federal estate tax is paid out before the inheritance is distributed, but it does reduce the pool of property to be distributed. There are, however, ways that the potential burden of the federal estate tax can be mitigated with proper planning.

FAQs

Q: What’s the Difference Between Inheritance Tax and Estate Tax?

A: An estate tax is something that is paid out before the estate is distributed to the heirs and beneficiaries. It’s determined based on the total value of the taxable portion of the estate. The responsibility of reporting and paying the estate tax falls on the executor or administrator of the estate. Inheritance tax, on the other hand, is something that is paid out after the estate is distributed. The value of the taxes owed is determined only by the value inherited by each individual, rather than on the estate as a whole. Reporting and paying the necessary taxes is the responsibility of the individuals who receive the inheritance.

Q: Which States Have an Inheritance Tax?

A: There is no federal inheritance tax. However, a few states do have an inheritance tax. This means that any inheritance associated with those states, whether being distributed from an estate originating in those states or going to a benefactor in those states, may be considered taxable. Each state has its own set of laws on inheritance tax, so it’s important to check the local laws. It is the responsibility of the inheritor to pay these taxes but, in many situations, it is also possible for the executor or administrator of the estate to collect the taxes from the benefactors and then pay the state. The states that currently have an inheritance tax are:

• Iowa
• Kentucky
• Maryland
• New Jersey
• Pennsylvania

Q: Can the IRS Come After My Inheritance?

A: Because there is no federal inheritance tax, the IRS cannot come after your inheritance. It is not considered taxable income. However, it is important to check if state taxes apply since, at the time of this writing, five states do still have an inheritance tax. Despite there not being a federal inheritance tax, it’s important to realize that, if you decide to sell the inheritance, especially in the future when the value may have increased, you could be responsible for capital gains taxes related to the increase in value of the inherited property. It’s important to work with an accountant or tax lawyer to make sure that you account for the potential taxes when you sell an inherited property.

Q: How Can I Reduce the Estate Taxes That My Family May Face?

A: While there is no federal inheritance tax, there is, as of 2023, an estate tax on estates with a value of $12.92 million or greater. In cases where this applies, there may be some interest in reducing the potential taxes on the estate so that more of the value may be passed on to the surviving heirs. There are a few different ways that this can be done:

• Marital Deduction – An unlimited amount of property may be transferred to one’s spouse free of the federal estate tax burden.
• Annual Gift Exclusion – As of 2023, a person is able to receive up to $17,000 as a tax-free gift from someone.
• State Estate Tax Deduction – It may be possible to deduct a portion of state estate taxes where that applies.
• Charitable Deduction – You may deduct from the estate the value of any donations being left to charities.
• Family Business Deduction – Eligible estates may be able to reduce by up to 20% the value of any qualifying family-owned business.

Prepare Your Estate

If you’re concerned about the taxation burden that may be placed on your estate, then it’s a good idea to talk with a lawyer about what approach may be ideal in your situation. At Sweeney Probate Law, we can help you understand all the taxation that your estate may be subject to. Contact us today for help with your estate.