How to Reduce Inheritance Taxes with Estate Planning
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One of the most significant issues that comes up is whether an inheritance would be taxed, whether someone else is receiving it or intends to leave their possessions to their loved ones.
A number of taxes can sometimes apply to the assets in an individual’s estate. However, most families are not affected by these taxes because they usually only apply to large estates. To find out how inheritance taxes operate, what types of taxes are applicable, and how to handle that tax responsibility, contact a tax accountant in Columbus, OH.
Estate planning tips to minimize taxes on your inheritance
Income taxes, capital gains taxes, inheritance taxes, and estate taxes are the primary four kinds of taxes that may be levied on an inheritance.
1. Estate tax
A federal tax known as the estate tax is levied on property that passes along when the owner passes away. The estate, not the beneficiaries, is liable for paying the tax. In other words, the estate taxes will have been paid by the time you get your inheritance.
Although most people will not have to deal with it, many people are concerned about how the estate tax may impact the inheritance they leave to their children. The first $13,990,000 of real estate is no longer subject to federal estate taxes in 2025, compared to $13,610,000 in 2024.
2. Inheritance tax
An inheritance tax is one that is levied on the beneficiary of an inheritance as opposed to the estate. A few states impose an inheritance tax, but the federal government does not. These states are:
- Kentucky
- Lowa
- Maryland
- Nebraska
- New Jersey
- Pennsylvania
The inheritance tax in Iowa is now being taken away. Deaths that occur in 2025 or after will no longer be recognized. However, the only state that imposes both an inheritance tax and an estate tax is Maryland. To put it another way, taxes on the assets distributed after a death must be paid by the estate as well as its beneficiaries. Who is subject to inheritance taxes varies by state, as does the amount they must pay. Similar to the IRS’s inheritance tax exemptions, each state has distinct exemptions.
3. Capital gains tax
When assets are sold, a federal tax known as the capital gains tax is applied (some states may have a capital gains tax). If you sell an item for higher than what you paid for it, whether it is your home or a share of stock, you can have to pay capital gains taxes.
4. ncome tax
In general, inheritances are exempt from income taxes. Neither life insurance nor the assets transferred from an investment or bank account are regarded as taxable income. You may have to pay income taxes on the assets held in pre-tax accounts.
Strategies for reducing taxes on your inheritance
Taxes can still be a burden for families that are currently struggling, even if they usually only apply to big inheritances. There are plenty of ways to lower your loved ones’ tax obligations, whether you have gained an inheritance, are expecting one, or have prepared your own estate and wish to do so.
5. Transfer assets into a trust.
Estate taxes can be minimized with the use of particular trust arrangements. Asset ownership is transferred from the initial owner to the trust under an irrevocable trust, and the beneficiaries ultimately get the assets. When the individual who created the trust dies, those assets are exempt from estate and inheritance taxes as they do not legally belong to them.
Another financial benefit of establishing a trust is helping the estate in avoiding probate. A trust could be helpful in establishing privacy during the estate settlement process.
6. Minimize pre-tax disbursements
If you take money out of an inherited pre-tax retirement account, you may be liable for income tax. Avoiding distributions can help you pay less in taxes. Here are some alternatives to think about:
- Withdraw only from Roth accounts, which are exempt from income taxes.
- Transferring pre-tax funds into a Roth account through a Roth conversion causes an initial tax burden but ultimately permits tax-free withdrawals.
