Inheriting money from a loved one can be life-changing for your finances. While the influx of cash may lead to a celebration, it is important to understand the implications it may have on your taxes. Understanding inheritance tax will help you and your family plan for the future and ensure the best financial decisions are made.

What Is An Inheritance?

An inheritance is a significant financial or material gain left to an individual or group of individuals by a deceased person. Receiving an inheritance could be due to different reasons, like through a will or a trust. Sometimes, it can be great, while at other times, it can be complicated and unwanted.

In most instances, the inheritance is distributed by an executor of a will, who ensures that the deceased's wishes are carried out. The executor will make sure that the property, assets, and money are distributed equitably, as stated in the document.

Different Types Of Inheritance

There are various types of assets that one can inherit. These might include money, real estate properties, stocks, investments, and other valuables. In some cases, inheritance could also include debts or mortgages left behind by the deceased. There are three categories for inheritances.

• Personal property: This includes items like jewelry, artwork, furniture, and other possessions.
• Real property: This includes land, houses, and different real estate types.
• Financial assets: This includes assets such as bank accounts, stocks, bonds, and retirement accounts.

Inheriting real estate properties that are not placed in a trust or stocks may require going to probate court, which could be a lengthy and costly process. However, there are instances where some assets can transfer automatically without going through this process.

What Is Inheritance Tax?

Some states impose an inheritance tax on the recipients of assets. In contrast to an estate tax, which the deceased's estate pays, the bequest recipient pays an inheritance tax. The inheritance tax is not common in the U.S. In fact, just six states have an inheritance tax as of 2023: Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania.

How Inheritance Tax Is Calculated

This tax is calculated based on the value of the inherited assets and is only applied to the portion that exceeds a specific exemption amount. You can expect to pay up if the inheritance is larger than the exemption threshold.

The good news is that the exemption amount and tax rate charged might vary depending on how close the relationship between the heir and the deceased was. Therefore, the closer the bond, the higher the exemption and the lower the rate of tax charged. This means that a spouse or a child will be subject to lower tax rates as opposed to a more distant relative, friend, or non-relative party.

How To Protect Your Inheritance

Taxes can take a significant chunk of your inheritance. However, there are steps you can take to minimize the impact.

Utilize Trusts

Trusts help to reduce estate and inheritance taxes by moving assets out of your estate and potentially lowering their value. Different types of trusts exist, each with its own rules and tax implications, so it's crucial to consult with an estate planning attorney to determine the best one for your situation.

Gift During Your Life

Instead of waiting, gift your valuables to your family and friends during your lifetime. Gifting assets can reduce the value of your estate and minimize estate taxes. But keep in mind that there are limits to how much you can gift tax-free each year, so it's essential to consult with a tax professional before making significant gifts.

Use Life Insurance Policies

These policies provide a tax-free death benefit to your heirs, which can help reduce the impact of estate and inheritance taxes. However, you need to ensure that the policy is structured correctly to avoid any tax implications.

Donate To Charity

This strategy can help you reduce the value of your taxable estate while supporting a worthy cause. By donating assets to a qualified charity, you may qualify for a charitable deduction on your income taxes.

Get Assistance

Professionals always know what’s best. Meet with an estate planning attorney or tax professional to go over your options and create a plan best suited for you and your estate.

Bottom Line

It is important to think about your inheritance during your lifetime. By understanding the tax implications of your assets and the different options available, you can ensure that your inheritance will be in the best place possible for your family and friends.