A common question asked by clients preparing a will or trust, and their children, is whether or not the beneficiary will have to pay any taxes on their inheritance. Before this question can be answered, the beneficiary needs to understand the term “taxes” actually encompasses three different types of taxes: inheritance taxes, estate taxes and income taxes. Whether or not your inheritance will be subject to any tax will depend on many factors.
The good news for most beneficiaries is they will never have to worry about “inheritance” taxes because only six states currently collect them. If the decedent from whom you are inheriting didn’t live in those states, then you won’t owe any inheritance taxes.
There are also a handful of states that have “state” estate tax. As with state inheritance taxes, if the decedent from whom you are inheriting didn’t live in any of those states, or own real estate in those states, then state taxes will not be owed.
“Federal Estate Taxes, and Federal Income Taxes” create different issues.
In 2023, the Federal Estate Tax Exclusion is $12.92 million, per person, and $25.84 million per husband and wife combined. If the decedent’s estate from whom you are inheriting is valued at less than that amount, no Federal Estate taxes will be owed by any of the beneficiaries.
In general, an inheritance in and of itself is not considered income, so no reporting is required on any federal or state income tax return. However, the property you inherit may have built in income tax consequences. For example, if you inherit a traditional IRA, or 401(k), then you will have to include all distributions you take out of those retirement plans on your federal income tax return and possibly your state income tax return.
Estate and Trust planning may involve tax implications for the beneficiary. Preparation of a will or trust requires knowledge, strategies for asset protection and consideration of current tax law. Be Educated! Be Proactive!