If you recently inherited a large sum of money, you may be wondering what your next steps should be. Coming into millions of dollars can be life-changing, but it can also result in new and unexpected financial obligations. That’s why it’s crucial to carefully consider the implications of your actions before making any decisions about what to do with your newfound wealth.
How Much Can You Inherit From Your Parents Without Paying Taxes?
In most states in the U.S., you will not have to pay an inheritance tax, no matter how much you inherit from your parents. The federal government does not impose an inheritance tax, and the vast majority of states do not collect inheritance taxes either. In fact, only six states (Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania) charge any inheritance taxes at all.
In these states, the amount of inheritance taxes you will owe depends on the value of the estate and your relationship to the deceased person. For instance, in Maryland, inheritances from estates worth less than $50,000 are exempt entirely, and in Kentucky, immediate family members are altogether exempt from inheritance taxes. If you live in one of the six states that assess estate taxes, you should discuss your situation with a knowledgeable local attorney to learn more about the rules in your jurisdiction.
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Estate Taxes
While inheritances taxes are imposed on the person who receives an inheritance, estate taxes are assessed on the estate itself before any of the assets are distributed. Estate taxes are more common than inheritance taxes, with the federal government, 12 states, and the District of Columbia all assessing estate taxes.
While you will not be required to personally pay estate taxes as the beneficiary of an estate, it’s important to understand how they work, as they can reduce the size of your inheritance. As of 2023, the federal estate tax applies to estates with values exceeding $12.92 million that are not being passed to the spouse of the deceased.
Additionally, Washington DC and 12 states (Connecticut, Hawaii, Illinois, Maine, Massachusetts, Maryland, New York, Oregon, Minnesota, Rhode Island, Vermont, and Washington) impose their own state-level estate taxes. In many of these states, the minimum amount for estate taxes to apply is much lower than the federal threshold, so you should consult with a local lawyer to learn more.
Do I Have to Report Inheritance Money to the IRS?
No. You generally do not have to report inheritance money to the IRS. However, if some or all of your inheritance is considered taxable income of the deceased, you will likely need to report it on your next federal tax return.
This is a limited exception that does not apply to a standard inheritance. It only applies if you receive money that would have been taxable income if the deceased person received it while they were still alive. If this is the case, then you must report that portion of your inheritance to the IRS in the same way that the deceased person would report it.
The most common example of this is compensation from the deceased person’s employer, such as a final paycheck, bonuses, and taxable retirement benefits. Other types of inheritance income that must be reported to the IRS include capital gains from property sold before death that are paid after death, royalties, and installment obligations.
Can I Gift My Inheritance to Someone Else?
Yes. Once you receive an inheritance, you can generally do whatever you want with it, including gifting it to someone else. However, you should understand the potential tax implications of doing so before you make a decision.
Under the federal gift tax, you are responsible for paying taxes on gifts that you give that exceed certain thresholds. Gifts include cash, personal property, and real estate that you transfer to someone else without receiving anything of a comparable value in return.
There are two important limits to keep in mind when determining if a gift will trigger the federal gift tax: the annual exclusion and the lifetime exclusion.
First, as of 2023, there is an annual threshold of $17,000 per person per year. That means you can give up to $17,000 to a single person without having to even report the gift to the IRS.
However, even if you give a gift that exceeds the annual exclusion, you will not have to pay gift tax unless you have also exceeded the lifetime exclusion amount for all reportable gifts in your lifetime. Just like the threshold for estate taxes, in 2023, that limit is $12.92 million.
Additionally, Connecticut is the only state that assesses a state-level gift tax. So if you happen to live in Connecticut, you should keep the state gift tax in mind when considering giving your inheritance away.
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What If Someone Contests My Inheritance?
If someone contests your inheritance, it is essential that you contact an experienced probate litigation attorney immediately. These types of cases are complex and should be handled by a knowledgeable professional who is experienced in handling inheritance disputes in particular, not an estate lawyer who usually just drafts wills and trusts. If you want to protect your inheritance, it’s vital to partner with a lawyer who has proven experience winning probate litigation cases in your area.