Getting the news that you are about to inherit from a loved one can be exciting, but you may also be concerned about what you may owe. We all know that an estate may be required to pay taxes, but what about inheritance tax? Whether you will need to pay inheritance tax depends on state law. Here is what you need to know.
What is inheritance tax?
When an heir or beneficiary receives money or property from an estate, a tax may be imposed on that inheritance. The federal government no longer imposes an inheritance tax, however, there are some states that still do. California does not have an inheritance tax. But if you inherit from someone who lives in another state, you should know the rules. Depending on the type of beneficiary you happen to be, the tax rate may be different. For instance, spouses and lineal heirs are typically taxed at a lower rate than distant relatives or beneficiaries who are unrelated to the deceased. In some states, spouses and lineal heirs pay no inheritance taxes at all.
How estate taxes are different from inheritance taxes
In general terms, estate taxes and inheritance taxes are different because of who is responsible for paying the tax. The estate tax is imposed on the transfer of property to someone else upon your death. So, the estate tax is imposed on the individual giving the property, instead of the person receiving it.
How estate taxes are calculated
The “gross estate” is all of the money and property owned by the deceased, and it includes cash, securities, insurance proceeds, real estate, annuities, trusts, and business interests. Once an accounting is made of the assets in the estate, applicable deductions are applied, leaving the net amount referred to as the “taxable estate.” The estate tax is then calculated based on a percentage of the taxable estate.
The differences between inheritance and gift taxes
Another concern many clients have is whether or not they will need to pay taxes on a gift from a loved one. You should first understand the difference between gifts and inheritances. A gift is property you receive from someone while that person is still alive. Generally, the person giving the gift is the one who will be responsible for paying gift taxes and reporting that gift to the IRS. The person receiving the gift does not have an immediate tax liability. However, there may be future tax consequences, such as when the gift is sold.
Can I reject or disclaim an inheritance
There are certainly some cases where rejecting an expected inheritance may be a better option. An heir can reject or disclaim an inheritance, but it requires more than simply telling the executor that you do not want the property. In order to ensure that you never become the owner of the property, there are certain rules you need to follow.
How to make a proper disclaimer
First of all, the disclaimer needs to be in writing and delivered to the person who is responsible for administering the estate. That would most likely be the executor or trustee depending on the nature of the inheritance property. The disclaimer should typically be made within 9 months of your loved one’s death. The most important thing to remember, in order for the disclaimer to be effective, is that you cannot accept any benefit at all from the property.
Disclaiming an inheritance in order to avoid estate taxes
The current exemption amount, or lifetime credit, is $5.45 million. Estates with a value below that amount do not incur estate taxes. The excess is taxed at 40 percent. Some clients wish to disclaim their inheritance so that they can avoid the potential of owing estate taxes when they die. The reality for some is that the addition of a substantial inheritance may cause that person’s estate to exceed the lifetime exemption amount. When this situation arises, it may be a better choice to disclaim the inheritance. However, before making this decision, discuss your options with your estate planning attorney.
Disclaiming an inheritance to protect government benefits
Another situation that may warrant rejection of an inheritance is when the recipient of the inheritance is also a recipient of state or federal benefits. Eligibility for some benefits may be based on need or have certain income limits. When that is the case, accepting the inheritance could jeopardize eligibility for those benefits, depending on the amount. In some cases, it would be more important to preserve healthcare benefits than to receive the inheritance.
If you have questions regarding inheritance tax, or any other estate planning needs, please contact the Schomer Law Group for a consultation, either online or by calling us at (310) 337-7696.