Inheritance Tax: What Do the Kids Owe?
Inheritance and Estate Tax: How do you keep your heirs safe from taxes on your estate? Well, put your funds in a trust, gift money to the kids every year, and relax! Death taxes probably won’t amount to much unless you’re super rich.
Definitions
Inheritance Taxes: Taxes on property you receive when a beneficiary dies. These are taxes that you, the beneficiary, are responsible for. The difference is that the estate pays the taxes in the first case, and the beneficiary pays taxes in the second.
Estate Taxes: Unlike your debts, your estate can be transferred to your children when you die. If you don’t have a will, the State will transfer your estate to your children in any way they feel is appropriate. That might be a good argument for drawing up a will.
The Best Way to Leave Inheritance for Your Children
Probate court can be a sticky wicket when parceling out an estate. The probate process takes its share, approximately 3 percent. The process can take 18 months. For instance, it gets problematic if someone makes a claim on the estate.
It takes eighteen months in enough cases that most people are forewarned of how long it takes to get through probate.
A trust can take as long. Cash in checking and savings accounts is distributed a couple of weeks after the death but with the supervision of a judge. Sometimes, money is dispersed if the deceased needs to cover funeral expenses. There are no taxes on the funds distributed from a checking or savings account. But the judge in the probate case may hold up the distribution of bank accounts even when no taxes are due.
Can You Inherit Money From Your Parents and Not Pay Taxes?
There’s no federal income tax on inheritances, so whatever tax you must pay will depend on the State you live in. Only a handful of States have an inheritance tax. Google your State and “inheritance tax.” Also, contact a tax consultant to determine if you live in one of the few States with an inheritance tax.
One way to give money to your beneficiaries is to provide them with gifts while you’re still living. This is not money to be reported to the IRS. To avoid confusion, discuss your desire to gift money to a beneficiary, with that beneficiary. Experts recommend that you explain that it’s part of their inheritance. If they’re still minors, the money can be put into an account available to the children when they reach the majority, again determined by the State you live in.
Gifting money has a top limit of $15,000 a year. The amount an estate can gift over a lifetime is in the millions. Unless you exceed these maximum limits, the IRS does not need forms or information.
Another way to pass on money to beneficiaries is to use Trusts.
What Taxes Are Beneficiaries Liable For?
You’ll find yourself with tax forms to file if you are the beneficiary of a pre-tax 401K, a pre-tax 403B, a pre-tax Roth IRA, a pre-tax pension, a retirement account, a life insurance policy, or a pre-tax savings bond. The critical determiner is the account’s status when the money went in. Was the money invested before it was taxed? Is it a tax haven until retirement, when taxes were due upon distribution?
Beneficiaries don’t pay inheritance taxes on properties or homes they receive. They don’t pay inheritance taxes on broker account proceeds unless it was a pre-tax IRA brokerage account. In each case, the institution will ask what amount of money you want to deduct to pay for the taxes, and you’ll get tax forms with each account where the beneficiary pays taxes.
If you don’t receive tax forms on something you think might be a pre-tax account, you should ask the institution.
Do Heirs Have to Pay Estate Taxes?
No, estate taxes are paid by the estate’s executor, and the amount is determined by how much wealth the estate is worth and what State it’s in. With the start point for paying estate taxes exceeding $12 million in 2023, most estates don’t suffer an estate tax.
The only people who suffer a “death tax” really are the very rich with estates worth more than 12 million dollars. However, six states charge an estate tax on ordinary people’s estates. On the other hand, if the estate of an average person owes back taxes, they will have to send it to the IRS.
Heirs aren’t responsible for this, but the estate’s executor is responsible for paying the money out of the estate. So, suppose your Uncle Bob is the executor of your grandmother’s estate (as well as a beneficiary). In that case, Uncle Bob will take money out of the estate after its value is determined, pay any back taxes to the IRS, and distribute the rest to the beneficiaries.
Do Children Have to Report Money Gifted to Them?
Can Parents Gift Their Children Large Sums of Money?
Well, that depends on what “large” means. The cap on annual gifts to beneficiaries is $15,000, and the lifetime cap on gifts for an estate is around 11 million dollars. You could give yearly contributions to beneficiaries, and they can accept that money free of taxes.
Does Charitable Giving Reduce Heirs’ Taxes?
If you’re a wealthy individual with high income and capital gains and face high estate taxes, charitable giving reduces your tax liability of each kind listed. The donations must go to 501 (c)(3) charities, that is, giving to non-profit organizations.
Of course, being a non-profit does not mean you qualify as a 501 c3 charity, so check with the IRS, which can tell you what non-profits qualify. The 501 c3 status is something that corporations must earn, and it takes some effort to allow.
By reaching out to your financial advisor, you can best determine which non-profit you should give to and how you should give to your chosen non-profit charity to maximize the benefit to your children. How to best work on your giving might make your heirs richer. That’s good for their budget.
My regular email newsletter is a great way to build relationships with my readers and share the blog posts and other content I’ve worked on. If you are interested, sign up below:
