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Learning the basics of inheritance and taxes in 2023

By Alaina Uhlenhoff

When you lose a loved one, especially a grandparent or parent, the last thing you want to be worrying about is understanding how any potential inheritance will be taxed. That is why it is important for families to have education and support to prepare of the transfer of wealth, and why it is worthwhile to invest time in learning about estate taxes when that feels like a distant need for sometime in the future.

In this blog we’ll explore the tax law surrounding inheritance, and share key ways that you can be prepared financially.

Inheritance Definitions

Inheritance, from a tax professional’s perspective, refers to the process by which individuals receive assets or wealth from a deceased person, often through a will or the rules of intestacy (when someone dies without a will). This transfer of assets can have tax implications for both the estate of the deceased person and the beneficiaries who receive the inherited assets.

When someone dies, their estate may be taxed with an “estate tax” and their beneficiaries may also have to pay “inheritance tax.” There are also sometimes “gift taxes” which affect large donations, gift tax and inheritance tax rules are often closely linked.

Basis Step-Up

Basis Step-Up is a significant benefit of inheritance, where when assets are inherited, their tax basis is adjusted to the fair market value at the time of the decedent’s death. This step-up in basis can reduce capital gains taxes for the beneficiaries if they decide to sell the inherited assets, as the capital gains tax is calculated based on the difference between the selling price and the stepped-up basis.

It is also possible to inherit retirement accounts, such as IRAs or 401ks, which may have tax implications. The required minimum distributions (RMDs) and tax treatment of these accounts can vary depending on the beneficiary’s relationship to the deceased and the type of retirement account.

Tax Basics

In addition to federal taxes some countries have state or regional inheritance or estate taxes that may apply in addition to the federal tax. Each state or region may have different tax rules and exemption thresholds.

In the United States there is no federal inheritance tax, and only 6 states have an inheritance tax. There is a federal Estate Tax, but The Tax Cuts and Jobs Act (TCJA) passed in 2017 significantly increased the federal estate tax exemption. The federal estate tax rates range from 18% to 40% on assets valued at over $12.92 million, more information here.

Another key factor involved in any estate or inheritance tax is the nature of the relationship between the deceased individual and their beneficiaries. Generally spouses are exempt from taxes, and children or dependents may be exempt or partially exempt.

Estate Planning

Proper estate planning can help families come up with strategies such as setting up trusts, charitable giving, and other mechanisms to optimize tax efficiency. Basic estate planning answers three questions, who is inheriting? What assets? And how? Each situation will be as unique as each family.

It’s important to note that tax laws can be complex and a vary between jurisdictions, there are also frequent changes and updates to tax code. So individuals and beneficiaries should seek guidance from qualified tax professionals to ensure compliance with relevant tax regulations and to make the most of their inherited assets.

The IRS has a great virtual assistant tool that can help you get an idea of the tax situation you inheritance is facing, find that resource here. Read an in-depth examination of federal estate tax returns here.

To learn more about Online Accounting and our services and resources, visit our site here.