Understanding Taxes as a Beneficiary

Inheritance and estate taxes seem like the same thing, and many people make that mistake, often interchanging the terms in conversation. However, each term refers to a specific concept and practice despite the similar subject matter.

Estate taxes are of no concern to heirs because they are paid by the estate. The tax is typically a federal matter, but some states also charge taxes. Because federal estate taxes generally are only charged once assets reach $11.4 million, most people will not have to worry about it. However, some states do charge at lesser amounts. Still, the estate tax is not your overall concern as a beneficiary.

Inheritance tax is a state tax paid by the beneficiary, but there is good news: only six states collect it. Therefore, you do not have to worry about an inheritance tax unless you or the decedent live in Iowa, Kentucky, Maryland, Nebraska, New Jersey, or Pennsylvania. If you or the decedent live in one of these states, you should know what to expect.

Understanding the Specifics of Inheritance Tax

Any individual inheriting cash, property, investments, or other assets within one of the six states will typically need to file a state-specific tax form. Additionally, each beneficiary should understand there is a timeline and deadline for filing, which will also be state-specific. If you want to avoid penalties and interest, it is best to contact an accountant in the state to help you sort through the particulars.

Charges and exemptions will vary by state. Pennsylvania does not require surviving spouses to pay an inheritance tax, and any children under 21 are also exempt. Additionally, the state permits non-taxable donations to some charities and organizations. From there, the state adopts a tiered system, with direct descendants and lineal heirs paying 4.5%, siblings 12%, and outside heirs paying 15%.

You should also know that whether you pay inheritance tax depends on where the decedent lived, not you. You are not exempt from paying if you live in a non-inheritance tax state, so it is best to contact a lawyer or accountant in the state of the benefactor to learn more about your potential obligations.

Reducing the Burden of Inheritance Tax Responsibilities

Unfortunately, as the beneficiary, you cannot do much to avoid paying inheritance tax. Still, there are a couple of ways to potentially ease the burden: talk to your friend or relative and prepare for the inevitable. While it can feel uncomfortable, even awkward, talking to a potential benefactor about your future obligations is an excellent way to figure out a tax strategy. There may be things a benefactor can do while alive to minimize the tax burden on specific heirs.

Putting money aside for the future tax bill is another excellent idea because it takes the financial surprise out of the equation. However, some things are not easy to factor against, such as tax changes or appreciation values.

As the adage goes, there are no guarantees in life aside from death and taxes. The best anyone can do is educate themselves about potential responsibilities and save for the inevitable.

Do you know of any inheritance tax strategies? Comment below.