When a loved one dies, the period of time that follows their passing can be incredibly stressful. It’s unfortunate, but any inheritance that you receive can add to that stress. If you don’t understand what receiving an inheritance can mean to you in the way of taxes, you may quickly find yourself overwhelmed and, ultimately, in trouble with the IRS and your state’s taxation office. Here are four things that you need to know about inheritance tax:
1. What is Inheritance Tax?
When you receive an inheritance from someone who has died, you are required to pay taxes on the money or property that you’ve received. The amount that you owe will be calculated by subtracting certain amounts from the “gross estate,” turning what is levied against you as the “taxable estate.” You will owe taxes on any items bequeathed to you, no matter if you are willed money, property or tangible goods.
2. Inheritance Tax vs. Estate Tax
In the United States, inheritance tax is calculated by individual states after estate taxes have been calculated by the federal government. The estate of the person who has died includes all of that person’s possessions and debts. After debts, administrative costs and funeral expenses are paid, what you have left over will be taxed by the IRS. Once the IRS receives their fair share, your remainder will be subject to inheritance tax by your state. You will be taxed on money, stocks, real estate, cars, boats, collections and more.
If your loved one was a millionaire, they should have hired an estate planner to ensure that their heirs weren’t taxed out of house and home. If, on the other hand, your loved one was a regular Jane or Joe, chances are high that it will be left up to you to figure out exemptions to estate and inheritance taxes.
When it comes to these taxes, the most common exemption is relationship-based. If you are the spouse of the decedent, you will not be subject to federal estate tax. If, however, the decedent is your parent, sibling, partner or friend, you can expect to pay taxes on what you were left, no matter your relationship. There are also amount-based exemptions that vary from federal to state governments. The federal threshold is $5 million, while state thresholds vary from $2 to $3.5 million. This means that if the estate is worth that much or less, you will not typically be subject to federal taxes or, in some cases, state taxes.
4. Tax Rates
When you are required to pay an inheritance tax by your state, your requirement will vary depending on the amount you’ve inherited. In essence, the more valuable your inheritance, the higher your tax rate will be. While spouses are not taxed, lineal descendants are taxed at a lower rate than siblings, and siblings are taxed at a lower rate than non-familial relations.
While some states follow a system of percentages based on relationships when it comes to inheritance tax, other states follow a three class system. For instance, in Indiana, there is a $100,000 exemption for those who fall into Class A, a $500 exemption for those in Class B and a $100 exemption for those in Class C.
If you have received an inheritance from a friend or family member, it’s important that you understand how and at what rate you will be taxed. By refusing to or neglecting to pay the taxes on your inheritance, you may find yourself facing stiff penalties from both the federal and state government. If you are unsure of what taxes you will be responsible for, be sure to consult a professional estate planner or tax attorney for assistance.
Katie Eldridge is a guest writer for www.netloans.co.uk where you can read more about Net Loans.