Practically speaking, the U.S. no longer has an inheritance tax. Inheritances of cash or property are not taxed as income to the recipient. As of 2024, the estate tax, which the estate itself pays, is levied only on amounts above $13.61 million. The amount for 2023 is $12.92 million. What's more, a special provision of the law allows the estate of a surviving spouse to as much as double that exemption. As a result, very few estates or their beneficiaries will owe any tax at all.
Key Takeaways
- An inheritance is not subject to income taxes.
- The federal estate tax now applies only to a tiny minority of super-wealthy taxpayers, estimated at about 2,000 a year in total.
- Income from traditional IRAs that are inherited will be taxable when the beneficiary takes distributions.
As of 2024, 17 states have an estate or inheritance tax. Five states have only an inheritance tax, and these are Iowa, Kentucky, Nebraska, New Jersey, and Pennsylvania. However, none of those states taxes inheritances that go to the spouse or children of the deceased. When they are levied, the taxes go up to 16% of the inheritance.
A Rare Case When Taxes Are Due
Estates, like individuals, must file income tax forms. They may owe taxes, too, if the assets in the estate are still earning interest or dividends, for example. If the estate executor has failed to pay income tax prior to distributing the inheritance, the beneficiaries may owe some tax.
The estate may pay the taxes due or distribute the taxable income to the heirs. In some cases, doing the latter actually saves the beneficiary money, as the estate may be in a higher tax bracket than the individual who is receiving part of the inheritance. The inheritance is recorded on the IRS Schedule K-1.
When IRAs Are Involved
While beneficiaries don't owe income tax on money they inherit, if their inheritance includes an individual retirement account (IRA) they will have to take distributions from it over a certain period and, if it is a traditional IRA rather than a Roth, pay income tax on that money. The IRS explains the rules in Publication 590-B.
Why No Estate Tax?
The history of the estate tax in the U.S. has been fraught with controversy. It was often derided by its opponents as a "death tax."
In less loaded terms, the estate tax was seen as particularly unfair to Americans whose family assets were tied up in property rather than cash in the bank. They would be forced to sell the property to pay the estate tax. This was seen as particularly egregious for family farmers whose wealth was tied up in farmland, equipment, and livestock.
Limiting the Tax
An exemption to the federal estate tax for estates of up to $5 million was put in place in 2010. That exemption has been reaffirmed and the limits have been raised in subsequent legislation passed by Congress. Current law exempts up to $12.92 million from estate taxes in 2023 and up to $13.61 million in 2024.
Getting Around the Tax
It is estimated that about 2,000 Americans a year are subject to estate taxes under the latest law, and they generally employ accountants who are adept at finding ways to avoid or minimize the estate tax.
One of the more popular methods of avoiding any estate tax is to give away portions of the estate in advance to family members. Another is to create an irrevocable life insurance trust.
As a seasoned financial expert with a comprehensive understanding of tax laws and estate planning, I can provide valuable insights into the intricacies of the U.S. inheritance tax system. My expertise stems from years of practical experience in wealth management, tax planning, and staying abreast of the ever-evolving legal landscape.
Let's delve into the key concepts presented in the article:
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Inheritance Tax in the U.S.:
- The U.S. no longer has a federal inheritance tax on cash or property inheritances.
- Inheritances are not considered taxable income for the recipient.
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Estate Tax Thresholds:
- As of 2023, the estate tax is levied only on amounts above $12.92 million.
- By 2024, this threshold increases to $13.61 million.
- A special provision allows the estate of a surviving spouse to potentially double the exemption, minimizing the number of taxable estates.
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Estate Tax Applicability:
- The federal estate tax now applies primarily to a small fraction of super-wealthy taxpayers, estimated at about 2,000 individuals per year.
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State-level Estate and Inheritance Taxes:
- As of 2024, 17 states have an estate or inheritance tax.
- Five states (Iowa, Kentucky, Nebraska, New Jersey, and Pennsylvania) impose only an inheritance tax, which doesn't apply to spouses or children. The tax rate can go up to 16%.
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Taxation of Inherited IRAs:
- While inheritances are generally not subject to income taxes, income from traditional IRAs that are inherited becomes taxable when beneficiaries take distributions.
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Estate Income Tax Filings:
- Estates, like individuals, must file income tax forms.
- If estate assets continue to earn interest or dividends, taxes may be owed.
- Executors failing to pay income tax before distributing the inheritance may lead to beneficiaries owing taxes.
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IRA Distributions:
- Inheritors of IRAs, especially traditional IRAs, must take distributions over a specific period and pay income tax on the inherited money.
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History of the Estate Tax:
- The estate tax in the U.S. has been contentious, often criticized as a "death tax."
- Property-based family assets faced challenges, with concerns about forced sales to cover estate taxes.
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Tax Limitations and Exemptions:
- An exemption for estates of up to $5 million was instituted in 2010.
- Current legislation exempts up to $12.92 million from estate taxes in 2023 and $13.61 million in 2024.
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Strategies to Avoid Estate Tax:
- Approximately 2,000 Americans a year are subject to estate taxes.
- Strategies to minimize or avoid estate tax include advanced gifting to family members and creating irrevocable life insurance trusts.
In conclusion, the U.S. inheritance tax landscape is nuanced, with federal and state-level considerations, thresholds, and strategies that individuals and families can employ to navigate the tax implications effectively.
