We have been talking about inheritance taxes at the state level thus far. California is not one of the few states that has an inheritance tax. However, if you inherit property from a friend or loved one who has passed away, you may still need to consider federal inheritance tax implications. The IRS does not treat your inheritance as income for federal tax purposes. Although there isn’t a federal inheritance tax in the strictest sense, there are certain tax considerations you should be aware of.
What is Federal Inheritance Tax?
While the IRS does not impose a federal inheritance tax, it is important to distinguish between inheritance taxes and other federal tax obligations, such as estate taxes. In the U.S., an estate tax is levied on the estate of the deceased before the assets are distributed to heirs. This means that while you, as the beneficiary, do not pay tax on the inheritance you receive, the estate itself might be taxed if it exceeds a certain threshold.
For example, in 2024, the federal estate tax exemption is $12.92 million per individual. This means that if the total value of the estate is below this amount, it will not be subject to federal estate tax. However, estates valued above this exemption may owe taxes on the amount that exceeds the threshold.
Inheritance and Other Tax Implications
Assume your grandma left you $1 million. When you file your federal income tax on April 15th, you won’t need to declare that money as income. An IRS agent won’t pursue you to attempt to seize some of your inheritance. This guideline still holds true whether you inherited money, assets, real estate, or even a family business.
However, certain types of inherited assets, such as retirement accounts (e.g., IRAs or 401(k)s), may trigger tax liabilities when you withdraw funds. The distributions you take from these accounts could be subject to income tax. Additionally, if you sell an inherited asset, such as a house, you may be subject to capital gains tax depending on the difference between the sale price and the asset’s stepped-up basis.
Planning Ahead: How to Minimize Tax Implications
Understanding federal inheritance tax and related tax obligations is crucial for effective estate planning. Proper planning can help minimize taxes for your heirs and ensure a smooth transfer of assets. Some strategies to consider include:
- Gifting during your lifetime: By gifting portions of your estate while you are still alive, you can reduce the size of your taxable estate.
- Setting up trusts: Trusts, such as irrevocable life insurance trusts, can help protect assets from estate taxes.
- Charitable donations: Donating to charity can reduce your taxable estate and potentially provide tax benefits.
Ask an Estate Plan Attorney Today
Don’t hesitate to seek professional guidance on your estate plan, especially if you’re concerned about federal inheritance tax and other tax implications. Visit Hudack Law Estate Planning Attorney to learn more about our services. We’re proud to serve California, Utah, and Arizona. Call our Toll-Free line at (877) 314-4309 to schedule a consultation with one of our experienced attorneys.