Is Your Inheritance Taxable & Top Ways to Protect Your Inheritance
Let's face it, inheritance can be a sensitive subject.
But don't worry, we're here to help. In this article, we'll walk you through everything you need to know about inheritance tax in plain English, so you can feel more confident and informed.
So, let's dive in!
What Is Inheritance Tax?
Inheritance tax is a tax that's charged on the assets you inherit from a deceased person's estate.
The person who inherits the assets typically pays this tax, not the estate itself. Inheritance tax laws vary depending on the country or state where you live, so it's crucial to understand the laws that apply to your situation.
Also read - Filing Taxes for the Deceased
Difference Between Inheritance Taxes and Estate Taxes
It's important to understand the difference between inheritance taxes and estate taxes since they're often mistaken for one another.
Estate taxes are taxes that are charged on the total value of a deceased person's estate. These taxes are generally paid by the estate itself, not the beneficiaries.
In contrast, inheritance taxes are taxes charged on the assets inherited by specific beneficiaries. In some cases, both estate taxes and inheritance taxes may apply.
The amount of inheritance tax you'll have to pay depends on several factors, such as the value of the assets you inherit and the tax laws in your situation. However, there are ways to avoid or reduce inheritance - we’ll discuss them a little later here.
Is My Inheritance Taxable?
The good news is that in most cases, you won't have to pay taxes on the inheritance itself. However, there are some cases where you may need to pay taxes on any income that your inheritance produces.
For example, if you inherit stocks or real estate that generates income, like rental income or dividends, you may need to pay income tax on that income. The amount of tax you owe will depend on how much income the inherited assets generate and your income tax bracket.
Also read - Capital Gain Tax on Sale of Foreign Real Estate
Does the IRS count inheritance as income?
Well, in general, inheritance isn't considered income for tax purposes. But, as mentioned earlier, you may need to pay taxes on any income that the inheritance generates.
If you're unsure whether you'll need to pay taxes on your inheritance, it's always a good idea to speak with a tax pro. They can help you with the tax laws that apply to your situation and ensure that you're following all the rules.
Never had a pro expat tax help before?
Check out how it works!
What are Inheritance Tax Thresholds?
Inheritance tax thresholds are used to determine how much of an estate can be passed on to beneficiaries tax-free.
The federal estate tax threshold is currently set at a high $12.92 million for 2023, so most people won't have to worry about paying federal estate tax. However, some states have their own estate tax thresholds, which may be lower than the federal threshold.
There are states in the United States that impose an inheritance tax, which is different from an estate tax. An inheritance tax is a tax on the beneficiaries who receive assets from the estate, rather than a tax on the estate itself.
The 6 states that currently have an inheritance tax in place as of 2023 are:
- New Jersey
The tax rate and exemptions for inheritance tax vary by state. For example, in Nebraska, only inheritances over $40,000 are taxed, and the tax rate ranges from 1% to 18%. In New Jersey, inheritances over $25,000 are taxed, and the tax rate ranges from 11% to 16%.
NOTE! Remember that inheritance tax thresholds can change over time, and they vary depending on where you live.
Top Ways to Protect Your Inheritance from Taxes
If you're concerned about the impact of inheritance taxes on your estate, there are several steps you can take to protect your inheritance from taxes. Here are some of the top ways to avoid or minimize inheritance taxes:
- Give gifts during your lifetime: One way to reduce the value of your estate is to give gifts to your heirs during your lifetime. The federal gift tax exclusion as of 2023 is $17,000 ($34,000 per married couple), per year, so you can give gifts up to that amount without incurring gift taxes.
- Establish a trust: A trust is a legal entity that can hold and distribute assets on behalf of your beneficiaries. By transferring assets to a trust, you can reduce the value of your estate and potentially avoid estate and inheritance taxes.
- Make charitable donations: Charitable donations can reduce the value of your estate and potentially lower your estate tax liability. By donating to a qualified charity, you can also support a cause that's important to you.
- Consider life insurance: Life insurance can be used to pay estate taxes and provide additional support for your heirs. By purchasing a life insurance policy, you can provide your beneficiaries with tax-free funds to cover any estate or inheritance tax liabilities.
- Plan ahead: Estate planning is critical to protecting your inheritance from taxes. By working with an experienced estate planning attorney, you can develop a comprehensive plan that takes into account your individual circumstances and minimizes your tax liability.
While it's not always possible to completely avoid inheritance taxes, taking steps to reduce the value of your estate and plan ahead can help to minimize the impact of taxes on your beneficiaries. It's important to work with a qualified financial advisor or estate planning attorney to develop a plan that meets your needs and protects your assets.
1. How much can you inherit from your parents without paying taxes?
For the 2023 tax year, the federal estate tax threshold is set at $12.92 million. So, unless the estate value is higher than that, you won't have to worry about paying federal estate taxes. However, some states have their own estate or inheritance tax rules that could have lower thresholds.
2. Do beneficiaries pay taxes on inherited money?
Most of the time, you don't have to pay federal income taxes on inherited assets. But, if the inherited assets earn income like rental income or stock dividends, you might have to pay taxes on that income.
3. Do I report inheritance on my taxes?
Usually, you don't have to mention inherited assets on your tax return. However, if the inherited assets earn income like interest or dividends, you might have to include that on your tax return.
4. What is considered a large inheritance?
It's tough to give a precise answer because it can vary based on many factors, including the size of the estate, the type of assets, and the cost of living. But, in general, an inheritance worth several hundred thousand dollars or more might be considered substantial.