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Many beneficiaries wrongly believe they’ll have to pay federal estate taxes on their inheritance

by Legacy Plan
June 16, 2023

They say that two things are certain in life – death and taxes. However, there’s plenty of confusion over who is responsible for paying federal estate taxes when a deceased person’s estate exceeds the allowable exemption amount.

The federal estate tax is a tax on the value of one’s estate at death. It can be confusing for a few reasons. First, the tax code is very complex. There are many different rules and regulations that govern federal estate taxes, and it can be difficult to understand all of them.

What is misunderstood about federal estate taxes?

The most common misunderstanding beneficiaries have about federal estate taxes is that they will have to pay taxes on what they inherit. This is not the case. Those who administrate an estate and its assets – an executor or personal representative named in the will or the successor trustee named in the trust agreement – is responsible for paying federal estate taxes from the estate’s assets, not the beneficiary. The estate administrator also is responsible for paying all of the deceased person's debts and other obligations

The estate tax is only paid on the portion of the estate that exceeds the exemption amount. For 2023, the exemption amount is $12.92 million per person. This means that an estate worth $12.92 million or less will not be subject to the estate tax. The amount of estate tax that is owed is determined by multiplying the value of the estate by the estate tax rate, which is currently 40%.

Estate administrators are required to file an estate tax return with the Internal Revenue Service (IRS) within nine months of the date of death. The estate tax return must include the value of all of the deceased person's assets, as well as any debts that were outstanding at the time of death.

If the value of the estate is less than the exemption amount, then no estate tax will be owed. However, if the value of the estate exceeds the exemption amount, then the estate tax will be owed on the portion of the estate that exceeds the exemption amount.

Do beneficiaries have to pay federal estate taxes?

A common misunderstanding is that beneficiaries will have to pay taxes on the assets they receive even if they are not cash. This is also not the case. Assets such as real estate, stocks and bonds are not subject to income taxation until they are sold. At the time of sale, the beneficiary will be responsible for paying taxes on any capital gains that have accrued since the asset was inherited.

Because beneficiaries may mistakenly believe that they could be liable for paying estate taxes, some have chosen to disclaim their inheritance. A disclaimer is a legal document that allows a beneficiary to refuse to accept an inheritance. However, a disclaimer does not eliminate estate tax liability. Again, the burden of paying any federal estate taxes rests with the estate itself.

The good news, for most taxpayers, is that the federal estate tax is not very common. Only a small percentage of estates are subject to the federal estate tax. However, this means that many people are not familiar with this tax, and they may not know if they are actually subject to it.

Unfortunately, the federal estate tax is often misunderstood. There are many misconceptions about the estate tax, and these misconceptions can lead to people making poor decisions about their estate planning.

What are some common beliefs about federal estate taxes?

Some of the common beliefs about the federal estate tax include:

  • The estate tax does indeed apply to everyone and estates of any size, but the exemption amount is very high. Again, in 2023, this means that only estates worth more than $12.92 million are subject to the estate tax.
  • The estate tax is unfair. This is a matter of opinion, but many people believe that the estate tax is unfair because it taxes people on money that they have already paid taxes on.
  • The estate tax is a disincentive to save. This is also a matter of opinion, but some people believe that the estate tax discourages people from saving because they know that their savings will be taxed when they die.

People whose estates may be subject to estate taxes certainly can benefit from professional advice because there are several strategies to obtain deductions and credits that can be used to reduce the amount of estate tax that is owed. Some of the most common deductions include the marital deduction and the charitable deduction.

The marital deduction allows a deceased person's estate to transfer assets to their surviving spouse without having to pay estate taxes on those assets. The marital deduction is unlimited, meaning that there is no limit on the amount of assets that can be transferred to a surviving spouse without having to pay estate taxes.

The marital deduction was created to encourage married couples to stay together and to provide for their spouses after their deaths. The marital deduction also helps to keep assets within the family, which can be beneficial for tax purposes and for estate planning.

The marital deduction is available to all married couples, regardless of their income or assets. However, there are some restrictions on the use of the marital deduction. For example, the marital deduction cannot be used to transfer assets to a surviving spouse who is not a U.S. citizen.

The estate tax is calculated on a per-person basis, which means that the estate of a married couple is not subject to the estate tax until the value of the estate exceeds $25.84 million.

Money with a golden bow on top

The charitable deduction is another potential way to reduce the burden of the federal estate tax. It allows a deceased person's estate to deduct the value of any charitable gifts made in the will or by other means. The charitable deduction is available for gifts made to qualified charitable organizations, such as churches, schools, hospitals and other nonprofit organizations.

The amount of the charitable deduction is limited to the value of the assets that are donated to charity. For example, if a person leaves $100,000 to a charity in their will, the estate will be able to deduct $100,000 from the taxable estate.

The charitable deduction can be a significant way to reduce the amount of estate taxes that are owed. For example, if the estate tax exemption is $12.92 million and a person leaves $10 million to charity, the estate will only owe estate taxes on $2.92 million.

The medical expense deduction, however, is not applicable to federal estate taxes, although this is a popular misconception. The medical expense deduction is only available for income tax purposes. The medical expense deduction allows taxpayers to deduct the cost of medical care that is not covered by insurance. The deduction is limited to the amount of medical expenses that exceed 7.5% of the taxpayer’s adjusted gross income (AGI).

Do medical expenses impact estate taxes?

For estate tax purposes, the cost of medical care is not deductible. This is because the estate tax is a tax on the value of an estate’s assets, not a tax on the income that is generated by those assets.

The federal estate tax has a long and complicated history. The first federal estate tax was enacted in 1797, but it was repealed in 1802. The estate tax was reenacted in 1862 during the Civil War, and it has been in effect ever since.

The estate tax has been modified many times over the years, which likely has led to confusion of how it works. The exemption amount, which is the amount of money that can be passed on to heirs without being subject to the estate tax, has increased significantly over time. In 1916, the exemption amount was $50,000.

How has the federal estate tax changed over the years?

The estate tax has also been subject to a number of different rates over the years. The highest estate tax rate was 77%, which was in effect from 1941 to 1976.

The federal estate tax is a controversial tax, and there are strong arguments on both sides of the issue. Supporters of the estate tax argue that it is a fair way to tax the wealthy. They argue that the wealthy have benefited from society and that they should pay their fair share in taxes. They also argue that the estate tax helps to reduce inequality.

Opponents of the estate tax argue that it is a double taxation, because the money that is taxed has already been taxed when it was earned. As mentioned, they also argue that the estate tax is a disincentive to save, because people are less likely to save money if they know that it will be taxed when they die.

Here are some of the major changes to the estate tax over the years:

  • 1916: The estate tax was enacted with a top rate of 10%.
  • 1941: The top rate was increased to 77%.
  • 1976: The top rate was reduced to 70%.
  • 1981: The top rate was reduced to 50%.
  • 1986: The top rate was reduced to 40%, and the exemption amount was increased to $1 million.
  • 2001: The estate tax was repealed for estates worth less than $1 million.
  • 2010: The estate tax was reinstated with a top rate of 35% and an exemption amount of $5.25 million.
  • 2012: The estate tax was made permanent with a top rate of 40% and an exemption amount of $5.34 million.
  • 2021: The exemption amount was increased to $11.7 million.
  • 2022: The exemption amount was increased to $12.06 million.
  • 2023: The exemption amount was increased to $12.92 million.

The estate tax is not the only tax that can be owed on assets at death. Other taxes, such as state inheritance taxes, may also be owed – but this obligation does rest with the beneficiary. In fact, the types of taxes that beneficiaries are responsible for when inheriting assets vary depending on the type of asset and the beneficiary's relationship to the deceased person.

What types of taxes do beneficiaries usually pay?

person viewing calculator through a magnifying glass

Here are some of the most common types of taxes that beneficiaries may have to pay:

  • Inheritance tax: The inheritance tax is imposed by some states – but not federally – on the receipt of assets from a deceased person. The tax is imposed on the beneficiary, not on the estate of the deceased person, and inheritance taxes are only imposed in certain states
  • Capital gains tax: If the asset that is inherited has appreciated in value since it was inherited from the deceased person, the beneficiary may have to pay capital gains tax on the appreciation. The capital gains tax is calculated on the difference between the fair market value of the asset at the time of death and the stepped-up basis of the asset.
  • Income tax: If the asset that is inherited generates income, such as dividends or interest, the beneficiary may have to pay income tax on that income.

It is important to note that the specific taxes that a beneficiary may have to pay will depend on the specific circumstances of the inheritance. If you are a beneficiary of an inheritance, you should consult with a financial professional to discuss your specific situation and to determine what taxes, if any, you may be responsible for paying.

Here are some additional tips for beneficiaries of inheritances:

  • Get professional help. A financial professional can help you understand the tax implications of your inheritance and make sure that you are not liable for any taxes.
  • Be organized. Keep track of all of the assets you inherit. This will make it easier to file your taxes and to manage your inheritance.
  • Plan for the future. Use your inheritance to achieve your financial goals. This may include saving for retirement, paying for college, or starting a business.

Inheriting an estate can be a great opportunity. However, it is important to understand the actual tax implications of your inheritance and to be prepared to manage your inheritance.

How do I create an estate plan?

There are numerous options and scenarios to consider when developing an estate plan that protects your legacy and achieves your objectives, and important decisions should be made with the advice of qualified lawyers and financial experts. Membership with Legacy Assurance Plan provides members with valuable resources and guidance to develop comprehensive estate plans that take life's contingencies into consideration and leave a positive impact for generations to come. Legacy Assurance Plan members also receive peace of mind that a team of trusted, experienced professionals will assist them in developing legal, financial and tax strategies that will meet their needs today and for years to come through periodic reviews.

This article is published by Legacy Assurance Plan and is intended for general informational purposes only. Some information may not apply to your situation. It does not, nor is it intended, to constitute legal advice. You should consult with an attorney regarding any specific questions about probate, living probate or other estate planning matters. Legacy Assurance Plan is an estate planning services company and is not a lawyer or law firm and is not engaged in the practice of law. For more information about this and other estate planning matters visit our website at legacyassuranceplan.com.

Phone - 844.445.3422
Email - info@legacyassuranceplan.com
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