Determine tax implications for beneficiaries

Depending on the total value of estate assets, heirs could face any combination of federal and state estate, inheritance, and gift taxes.

In some situations, such as when the deceased owned a business that is being transferred to heirs, heirs could even face additional income taxes if they keep the business in operation.

Estate, inheritance, and gift taxes can be highly complex and result in a significant tax bill for the deceased’s heirs and beneficiaries.

State and federal tax laws should be reviewed to determine any potential tax implications.

Federal Gift & Estate Taxes

While living, individuals can give $16,000 to an unlimited number of other individuals each year without tax ramifications.

This means the recipient of gifts up to $16,000 per year are not required to report the gift as taxable income.

Over the course of one’s lifetime, an individual can gift up to $11.58 million to another individual without tax ramifications.

This same limit applies to one’s inheritance. Any inheritance received over this limit, however, is subject to taxation at a rate of 40% - which could result in a huge tax bill all at once.

State Estate, Inheritance & Gift Taxes

States differ in whether and how they tax transfers of property, including inheritance.

In general, gift taxes are imposed on property transferred while the deceased was still living, while estate and inheritance taxes are imposed on transfers of property made after the deceased’s passing.

The following states have a combination of gift, inheritance, and estate taxes:

• Connecticut
• Maryland
• New Jersey
• New York
• Pennsylvania
• Washington, D.C.
• Hawaii
• Illinois
• Iowa
• Kentucky
• Maine
• Massachusetts
• Minnesota
• Nebraska
• Oregon
• Rhode Island
• Vermont
• Washington

Fortunately, there are some tactics for reducing or avoiding taxation on inherited assets.

Heirs who are concerned about the tax implications of the inheritance should speak with an accountant before accepting any distributions from the estate.

An accountant can help heirs employ tactics to avoid or reduce the taxation on their inheritance.

The taxes an heir or beneficiary pays on their inheritance depends on the type of asset received, the account in which it was held, and how and when they “cashed out” the asset.

As such, it is important for the heir or beneficiaries to determine whether they will have to pay taxes on particular assets, and how much they will have to pay.

Inheritance of Retirement Assets

An heir inherits a retirement account which was funded with pre-tax dollars (e.g. 401(K) or IRA), state and federal taxes have not been paid on the asset.

If and when money is withdrawn from one of these inherited retirement accounts, the amount withdrawn is considered taxable income.

If an heir inherits a retirement account and withdraws the entire amount in a single year, they could face a hefty tax bill all at once.

It could also potentially push the heir into a higher income tax bracket, depending on the value of the retirement account and the heir’s existing income.

Inheritance of Investment Assets

Taxation on inherited investments (e.g., stocks, bonds) is a complex subject.

For inheritance tax purposes, investment accounts are typically taxed on a “stepped-up” cost-basis, which means the heir is taxed on the fair market value of the assets on the deceased’s date of death.

This would cause the heir to incur either a capital gain or loss.

If the deceased’s investments are held for a long time, they could be worth significantly more than when the heir inherited the investment - resulting in a hefty capital gains tax.

For instance, let’s say an heir inherits shares worth $1,000 at the time of the deceased’s passing. The heir later sells the shares for $15,000.

That means the heir who inherited the shares saw a capital gain of $14,000 (the amount the shares were worth at the time of sale minus the value of the shares at the time of the deceased’s passing).

Such a windfall could result in a hefty capital gains tax for the heir.

##Inheritance of Real Estate For tax purposes, the value of the deceased’s real estate on their date of death becomes the cost-basis.

For example, if the deceased’s home was worth $100,000 on their date of death, and the heir sells the home a year later for $180,000, the heir will need to report $80,000 in capital gains on their tax return once the home sells.

If the heir decides to rent out the home, they will have to report the rental income on their tax return as well.

##Inheritance of Business Assets Much like inheriting real estate, inheriting a business can lead to a heft tax bill.

If the heir sells the deceased’s business for a gain, they will need to pay capital gains taxes on the profit realized.

For instance, if the business was valued at $500,000 when the deceased passed, and was sold two years later for $750,000, the heir will have to pay capital gains taxes on the $250,000 profit realized when the business was sold.

If the heir decides to keep the business, they will have to report the business income on their tax return as well.