Is Inheritance Taxable?
Most people have imagined what they would do with a sudden windfall. These musings usually involve paying off debts and make luxurious purchases. Is there a downside to inheriting besides the possible lifestyle changes?
The answer depends on how much is inherited, what is inherited and where the person lives. Laws regarding inheritance can sometimes be so complex and may leave an individual wondering if they should accept the bequest at all.
An inheritance is not always a lump sum of unexpected money. Anything of value handed down legally is an inheritance, be it a home, a single piece of furniture or even Uncle Charlie’s seat on the board of directors. Inheritance is recognizable as either tangible or intangible.
Simply put, tangible property is touchable like a car or a home. Intangible property, while possibly valuable, is something that is not touchable such as a patent or ownership in a corporation.
An estate is a person’s property that is legally transferable. When a person dies, everything they have of value is referred to as their estate. It may consist of tangible and intangible property.
When a person arranges the distribution of their estate prior to death, it is referred to as estate planning. Estate planning is usually done with the assistance of a lawyer and may include a will, trust, insurance policy and consideration of tax laws.
Why is it important to distinguish between an inheritance and an estate? At the federal level, taxation is on the estate, itself, rather than the inheritance. If a person receives an inheritance, taxes are taken from the estate prior to distribution to heirs.
When someone dies, a compilation of their assets is submitted to the IRS, depreciation and debts are considered and a “taxable estate” results. Most estates are not large enough to incur federal taxation based on the current year’s IRS guidelines.
For example, in 2009, only estates exceeding $3.5 million are subject to federal estate tax.
At the state level, inheritance taxation is much more complicated and differs from state to state. The amount of inheritance tax may depend on factors like federal taxation amount, relationship to the deceased and overall estate value.
In 2009, only 11 states still collect inheritance tax. To decipher inheritance tax, the best option is to consult a tax specialist, attorney or, in the least, the state IRS website.
Refusing an Inheritance
Let’s face it, an inheritance is not always a windfall and electing to forgo an inheritance is a practical choice in some cases. The official term when refusing an inheritance is called “disclaiming,” and it allows the inheritance to pass to the next person in line.
To qualify, the disclaimed inheritance must have no strings attached. The decision is irrevocable (not reversible) and has no contingencies (conditions) — it is as if the person was never an heir.
Rules governing inheritance disclaimer are part of IRS Section 2518(b).