Understanding the Inheritance Tax

There are a lot of considerations when it comes to comprehensive estate planning, not the least of which is choosing the vehicles you will use in your estate planning strategy to meet your needs. However, individuals inheriting from you may also need to be concerned with important considerations like the potential tax consequences of being a beneficiary.

What is the inheritance tax?

One of the most common tax considerations when it comes to estate planning is the estate tax itself, a federal tax applied to estates valued at over a certain amount. The new tax bill doubles the exemption, and many people will not have to worry about the federal estate tax at the moment. However, many states also have estate taxes – including New York. In New York, the current state tax exemption is approximately half of the new federal exemption amount and sits at $5,250,000. That means any estates worth over that amount in New York are subject to the state estate tax even if they are no longer subject to the federal estate tax.

But what about the inheritance tax? The inheritance tax is not as well known, due in part to the fact that it is less common. New York does not have an inheritance tax, but other states do and it is important to take the potential impact of an inheritance tax on a beneficiary when determining how to distribute your assets.

An inheritance tax is just that: a tax liability on a person’s inheritance. Generally, states that have an inheritance tax exclude surviving spouses. And may also exclude other direct family members like children. There may be an exemption amount for other related relatives such as cousins or siblings, but often unrelated individuals are subject to higher inheritance taxes. While a decedent’s estate is responsible for any potential estate tax liabilities on both the federal and state level, the individual beneficiary is responsible for any inheritance tax they might face. The amount of tax that is to be paid is generally determined by the value of the inheritance.

Can your beneficiary avoid the inheritance tax?

If you have beneficiaries that live in one of the states that imposes inheritance taxes – including New Jersey, Pennsylvania, Maryland, Kentucky, Iowa, and Nebraska – it is important for you and/or them to work with an experienced estate planning attorney in that jurisdiction to get a better understanding of what the potential tax liabilities for the beneficiary might be.

Leaving inheritances to charities is a potential way to avoid the inheritance tax consequences that might otherwise befall a beneficiary. These types of transactions are often exempt from inheritance taxes to help encourage charitable contributions.

Gifting may also help you enable beneficiaries to avoid inheritance taxes in their state. You are provided with an annual exemption amount of how much money you can give to an individual before it is taxed, and you can continue to give that amount on an annual basis until you have reached your lifetime cap. However, gifting that occurs within a few years of death is often considered as having happened in contemplation of death, so it might not be enough to help your beneficiary avoid a significant tax bill.

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