Receiving an inheritance may be exciting for some, but stressful for others. There are many questions that arise when individuals get word that they are about to inherit from a loved one. The most common question is: will I have to pay an inheritance tax? Luckily, if you live in California, there is no California inheritance tax, but that is not true in every state. Here is what you need to know:
What is inheritance tax?
An inheritance tax, as the name implies, is a tax imposed by the government whenever a beneficiary receives money or assets from the estate of another. The rate of the inheritance tax, that is, the percentage of the inheritance that is calculated to determine the tax amount usually depends on the type of beneficiary. For instance, spouses and lineal heirs descending from a common ancestor, are usually taxed at a much lower rate than distant heirs or unrelated beneficiaries. The federal government does not impose an inheritance tax and neither do most states. Again, there is no California inheritance tax.
What is the difference between inheritance taxes and estate taxes?
The primary difference between estate tax and inheritance tax is who owes the tax. Estate tax is the tax imposed on your right to transfer property to others upon your death. Estate taxes are calculated once an accounting has been made of the assets included in your overall estate. That total value is referred to as your “gross estate.” These assets typically include things like cash, securities, insurance proceeds, real estate, annuities, trusts, and business interests. After the applicable deductions are considered, the net amount of your assets is known as your “taxable estate.” The estate tax is imposed based on the amount of your taxable estate. Unlike an inheritance tax, the estate tax is imposed on the person giving the property, instead of the person receiving it. The federal government imposes an estate tax on estates over $5.45 million in 2016. California has no estate tax.
The difference between gift taxes and inheritance taxes
Another common concern is whether you have to pay taxes on property or money received from someone while that person is still alive. This is considered a gift, not an inheritance. In most cases, the person who gives the gift (the donor) is ultimately responsible for paying taxes on that money or property, after reporting the gift to the IRS in IRS Form 709. The person receiving the gift typically does not face any immediate tax consequences. Annual gifts under $14,000 per person do not need to be reported to the IRS. However, if that property is later sold, then there may be tax consequences at that point.
What if I don’t want my inheritance?
Although there is no California inheritance tax, there could be certain situations where an individual would rather reject an inheritance. If you want to reject or disclaim an inheritance it can be done, but it takes a little more than simply telling the executor you do not want the property.
How to properly disclaim an inheritance
In order for a disclaimer to be legitimate and enforceable, it needs to be in writing and delivered to the person responsible for administering the estate. In most cases, that would be the executor or trustee, depending on the nature of the property being inherited. The disclaimer should generally be made within 9 months of your loved one’s death. In order for the disclaimer to be effective, you cannot accept any benefit from the property whatsoever.
Reasons you may want to disclaim an inheritance
Some clients decide to disclaim an inheritance in order to avoid the potential of owing estate taxes when they die. For some people, a substantial inheritance could result in that person’s estate exceeding the lifetime exemption amount, meaning they would ultimately owe taxes on their estate. The current exemption amount is $5.45 million. While estates that are valued below that amount do not incur estate taxes, any excess would be taxed currently at 40 percent. If this is the case for you, it may be a better option to disclaim the inheritance. However, before you make this important decision, discuss your options with your estate planning attorney.
Another situation that may cause you to consider rejecting an inheritance is when you are the recipient of state or federal benefits. Eligibility for certain benefits can be based on need or have specific limits on income. In those cases, accepting a substantial inheritance could very easily jeopardize eligibility for those benefits. So preserving healthcare benefits may be more important than receiving an inheritance. If you are receiving public benefits and are about to receive a gift or inheritance, it is critical that you consult with an experienced and qualified attorney who may be able to assist you in preserving your benefits.
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If you have questions regarding inheritance taxes, or any other estate planning needs, contact the Northern California Center for Estate Planning and Elder Law for a consultation, either online or by calling us at (916) 437-3500.