What Should You Know About Inheritance Taxes?

Inheritance Tax
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Inheritances come in all shapes and sizes. People inherit financial accounts, real estate, jewelry, and personal items. The article “Will I Pay Taxes on My Inheritance” from Orange Town News advises that whatever kind of inheritance you have, you’ll want to understand exactly what, if any, inheritance taxes might be due.  An inheritance might also have an impact on Medicare premiums or financial aid eligibility for a college-aged child. Let’s look at different assets and how these assets may impact a family’s tax liability.

Bank Savings Accounts or CDs. As long as the cash inherited is not from a retirement account, there are no federal taxes due. The IRS does not impose a federal inheritance tax. However, there are some states, including Iowa, Kentucky, Maryland, Nebraska, New Jersey and Pennsylvania, that do have an inheritance tax.

Primary Residence or Other Real Estate. Inheriting a house or property is not a taxable event. However, once you take ownership and sell the house or property, there will be taxes due on any gains. The value of the house or property is established on the day of death. For example, if you inherit a house valued at death at $250,000, and you sell it a year later for $275,000, you’ll have to declare a long-term capital gain and pay taxes on the $25,000 gain. The cost-basis is determined when you take ownership.

Life Insurance Proceeds. Life insurance proceeds are not taxable and are not usually reported as income by beneficiaries. However, there are exceptions: if interest is earned, which can happen when receipt of the proceeds is delayed, this is reportable. The beneficiary will receive a Form 1099-INT. The interest is taxable by both state and federal tax agencies. If the proceeds from the life insurance policy are transferred to an individual as part of an arrangement before the insured’s death, the proceeds are also fully taxable.

Retirement Accounts: 401(k) and IRA. Distributions from inherited traditional IRAs and non-inherited IRAs are taxable. However, distributions from an inherited Roth IRA are not taxable, unless the Roth IRA was established within the past five years.

Pending legislation will result in upcoming changes to retirement accounts, so it will be important to check on this with your estate planning attorney. Inherited 401(k) plans will eventually be taxable, but the tax rate depends upon the rules of the 401(k) plan. Many 401(k) plans require a lump-sum distribution upon the death of the owner. The surviving spouse is permitted to roll the 401(k) into an IRA, but if the beneficiary is not a spouse, they may have to take the lump-sum payment and pay the resulting taxes.

Stocks. Generally, when stocks or funds are sold, capital gains taxes are paid on any gains that occurred during the period of ownership. When stocks or funds are inherited, the cost basis is based on the fair market value of the stock or fund at the date of death.

Artwork and Jewelry. Collectibles, artwork, or jewelry that is inherited and sold will incur a tax on the net gain of the sale. There is a 28% capital gains tax rate on collectibles, artwork, and jewelry compared to a 15% to 20% capital gains tax rate that applies to most capital assets. The value is based on the value of the item(s) at the date of death or the alternate valuation date. This asset class includes anything that is considered an item worth collecting; for example, rare stamps, books, fine art, antiques, and coin collections fall into this category.

To ensure you’ll know what kind of tax liability comes with an inheritance, speak with an estate planning attorney before signing and accepting an inheritance. Additionally, take your time before making any big financial decisions.  Most people are advised to wait about a year before making any big financial decisions after a loss.

Reference: Orange Town News (May 29, 2019) “Will I Pay Taxes on My Inheritance”

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