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Posted by Pat Raskob

Simple Ways to Protect Your Inheritance From Taxes

Simple Ways to Protect Your Inheritance From Taxes

For federal tax purposes, inheritance is not classified as income, no matter what you inherited – cash, property, or investment. However, whatever you earn on such an inherited asset can be taxed, except the source is tax-free. Your income needs to contain interest income from the inherited cash alongside the dividends from inherited stocks. Examples are:

  • Whatever gain you realize on selling property or investment you inherited will be taxed, although one can claim losses on such sales as well. 

  • What the state will tax on your inheritance varies. The state's revenue department of taxation will have more details, or you can consider asking a tax professional. 

Protecting Your Inheritance from Taxes 

Here are legal ways to protect your inheritance from tax:

Direct everything into a trust 

For everyone expecting an inheritance from parents, grandparents, or any family member, it is good to advise that they establish trust for the asset. With a trust, one can easily pass assets to beneficiaries without dealing with probate. While trusts are like wills, they avoid state probate requirements alongside the expenses that come with it. 

  • A revocable trust allows the grantor to take out the asset when needed

  • An irrevocable trust will generally fix the asset until the death of the grantor

Parents should not make the mistake of putting such assets into a similar name with their kid as this increases the tax obligation of the kid.

  • On the account holder's death, the joint holder will inherit the asset and the basis, which will help determine the taxable gain in value through the years.

  • For assets held in the long term, the tax consequence might be enormous when the kid sells such assets.


Reduce Distribution on Retirement Account 

Retirement assets that you inherited cannot be taxed until they are distributed. Rules are guiding the distribution provided such a beneficiary is not the spouse.

  • On the death of the spouse, the surviving spouse can acquire the IRA and take over. Required Minimum Distribution (RMD) will start at 72, the same way it will happen for the IRA of the surviving spouse.

  • For someone that inherited a retirement account from another person, not the spouse, it is possible to transfer such funds to an IRA you inherited in your name. You, however, need to commence taking off the minimum distribution at the year, or a year after you got such inheritance, no matter your age. 

  • It is a good idea to elect the single life method of estimating the RMD amount for someone younger than the decedent, depending on your age. Since you will have a small minimum distribution, the taxes will be small, leaving such money to grow without the tax for a long time.

Explore the Alternate Valuation Date

Ideally, a property's basis in the decedent's estate is the property's fair market value at death. However, there are cases when the executor goes with the alternate valuation date – 180 days after the death date. 

  • The availability of alternate valuation is based on its ability to decrease the gross estate amount alongside its tax liability. With this, the beneficiary gets a larger amount.

  • All properties sold or disposed of within 180 days will be valued on the date of the sale.

  • For estates not subject to estate tax, the date of death is the valuation date.


Donate Some of the Money

While this seems counter-intuitive, there are times it makes sense to give part of your inheritance out. This will help those in need and reduce any taxable gain you have on the inheritance with the deduction that comes from donating to an eligible charity group. 

  • If you leave money to people on your death, it is good to give gifts annually to your beneficiaries while living. 

  • You can give a specified amount to each person while escaping the gift tax

With gifting, your loved ones not only get an immediate benefit, but your estate size also reduces, which makes sense for people near the taxable amount. Make sure to discuss with an estate planning pro to help ensure you are updated on the changes to estate tax regulations. 



Pat Raskob
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