After someone dies, their assets are usually transferred to their heirs—whether that be their spouse, children, or other blood relatives. Whenever assets are transferred, a tax may have to be paid on them in the form of an inheritance tax, estate tax, or both. Investopedia says, “An inheritance tax is a tax imposed by some states on the recipients of inherited assets. In contrast to an estate tax, an inheritance tax is paid by the recipient of a bequest rather than the estate of the deceased.” This means that you, as the beneficiary, are responsible for paying whatever inheritance tax is due. Spouses are typically exempt from inheritance taxes.

Whether or not you have to pay inheritance tax depends on which state you live in, the value of the inheritance, and your relationship to the person who passed away and left you their assets. It’s important to note that there is no federal inheritance tax. However, if the deceased person has combined assets over $12.06 million (as of 2022), an estate tax ranging from 18–40% must be paid at the federal level out of their estate before assets can be distributed to beneficiaries. According to the IRS, “The Estate Tax is a tax on your right to transfer property at your death. It consists of an accounting of everything you own or have certain interests in at the date of death (Refer to Form 706). The fair market value of these items is used, not necessarily what you paid for them or what their values were when you acquired them. The total of all of these items is your ‘Gross Estate.’ The includible property may consist of cash and securities, real estate, insurance, trusts, annuities, business interests, and other assets.” Certain deductions are allowed; once those have been accounted for, you arrive at your taxable estate value.

One important caveat to the $12.06 million exemption—this is a temporary figure set to sunset in 2025. This means that the lifetime exemption will revert back to $5.49 million if Congress does not make the current number permanent.

Here are five ways to minimize taxes when passing assets on to beneficiaries:

1. Live In a State That Doesn’t Have an Inheritance or Estate Tax

Living in a state that doesn’t have an inheritance or estate tax means you may not have to pay taxes on your newfound riches if the estate’s combined assets are below $12.06 million. Thirty-three states don’t have estate or inheritance taxes. Consult this Kiplinger article for the 33 states without these taxes. You can also view the states that do levy estate tax, inheritance tax, or both here.

If you plan on leaving an inheritance to your beneficiaries and you want to avoid taxes, you may want to ensure you’re in a state that doesn’t have an inheritance or estate tax. Keep in mind that if your combined assets are over $12.06 million, you may not be able to avoid estate tax at the federal level.

2. Give Gifts Now

According to the IRS, as of 2022, you can gift up $16,000 per person annually without tax implications. There is no limit to the number of people to whom you can gift the money. If you are married, your spouse can also gift $16,000 separately without tax consequences. Combined, you and your spouse can give away $32,000 to as many people as you wish.

If you’re feeling extra generous and gift above the maximum allowed amount of $16,000 per recipient, you still may not have to pay taxes on it; instead, it will count towards the $12.06 million threshold you are allowed before the estate tax kicks in. Remember, as of 2022, you don’t have to pay estate taxes if your combined assets are below $12.06 million.

Do note that the $12.06 million tax exemption for estate tax is only in effect until 2025. After 2025, unless the tax laws are changed, the tax exemption will be $5.49 million. So, if you have a lot of money to give, you can give as much as $12.06 million before 2025 without triggering any estate tax!

3. Instruct That All Your Money Goes to Your Spouse

If you are married, you can avoid inheritance and estate tax by leaving your assets to your spouse. According to NONO, “Assets left to a surviving spouse are not subject to federal estate tax, no matter how much they are worth—IF the surviving spouse is a U.S. citizen. This rule is called the unlimited marital deduction.” There is no limit on how much you can leave to your spouse tax-free. Make sure your estate planning documents clearly and legally outline that all your assets should go to your spouse.

4. Create an Irrevocable Trust

According to Investopedia, an irrevocable trust can be created “to take advantage of the estate tax exemption and remove taxable assets from the estate. Property transferred to an irrevocable living trust does not count toward the gross value of an estate. Such trusts can be especially helpful in reducing the tax liability of very large estates.” Creating an irrevocable trust and putting your assets into that trust allows you to transfer ownership of your estate to the trust. This means you’re no longer the owner of the trust. Once your assets are in the irrevocable trust, there won’t be any transfer of ownership after you die, which means inheritance and estate tax will not be levied on your assets. This will also avoid probate court—a potentially costly and time-consuming process. Whoever is listed as the beneficiary of the irrevocable trust can continue to enjoy whatever assets are in the irrevocable trust without tax implications.

5. Donate to Charity

You can donate unlimited amounts of money to a qualifying charity organization of your choice to lessen or eliminate your estate’s tax burden. If you’re close to or above the taxable amount of $12.06 million (as of 2022), making charitable donations can reduce the size of your estate and potential tax burden. As long as the balance of your assets remains at or below $12.06 million, your estate may not be subjected to any estate tax.

Takeaway

You can minimize or avoid inheritance and estate taxes in many ways. The easiest way to avoid these taxes is to live in a state that doesn’t have inheritance tax and ensure your estate isn’t valued at more than $12.06 million as of 2022. Of course, living in a state that doesn’t have an inheritance tax isn’t possible for everyone. In that case, some of the other strategies listed here can help reduce your estate’s tax liabilities.

It’s impossible to predict the future but planning for the possible income tax consequences your beneficiaries now can help ease a burden later. Make estate planning a priority and consult with a financial advisor or estate-planning attorney. Tax laws can and do change often, so we advise you to review your estate plan and asset transfer strategy annually to be sure that your plans are still effective.

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This blog expresses the author’s views as of the date indicated, are subject to change without notice, and may not be updated.  The information contained within is believed to be from reliable sources.  However, its accurateness, completeness, and the opinions based thereon by the author are not guaranteed – no responsibility is assumed for omissions or errors.  This blog aims to expose you to ideas and financial vehicles that may help you work towards your financial goals. No promises or guarantees are made that you will accomplish such goals.

Past performance is no guarantee of future results, and any expected returns or hypothetical projections may not reflect actual future performance or outcomes. All investments involve risk and may lose money. Nothing in this document should be construed as investment, tax, financial, accounting, or legal advice. Each prospective investor must evaluate and investigate any investments considered or any investment strategies or recommendations described herein (including the risks and merits thereof), seek professional advice for their particular circumstances, and inform themselves about the tax or other consequences of any investments or services considered. 

Investment advisory services are offered through Liberty Wealth Management, LLC (“LWM”), DBA Liberty Group, an SEC-registered investment adviser.  For additional information on LWM or its investment professionals, please visit www.adviserinfo.sec.gov  or contact us directly at 411 30^th Street, 2^nd Floor, Oakland, CA  94609, T: 510-658-1880, F: 510-658-1886,  www.libertygroupllc.com. Registration with the U.S. Securities and Exchange Commission or any state securities authority does not imply a certain level of skill or training.

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References

Berry-Johnson, Janet. (May 31, 2022). Inheritance Tax: What It Is, How It’s Calculated, Who Pays It. Investopedia. https://www.investopedia.com/terms/i/inheritancetax.asp

IRS. (n.d.). Estate Tax. https://www.irs.gov/businesses/small-businesses-self-employed/estate-tax

IRS. (n.d.). What’s New – Estate and Gift Tax. https://www.irs.gov/businesses/small-businesses-self-employed/whats-new-estate-and-gift-tax

Mengle, Rokky; Block, Sandra; Muhlbaum, David. (September 2, 2022). 33 States with No Estate Taxes or Inheritance Taxes. Kiplinger. https://www.kiplinger.com/slideshow/retirement/t021-s001-states-with-no-estate-taxes-or-inheritance-taxes/index.html

Orem, Tina, and Davis, Chris. (May 26, 2022). Inheritance Tax: What It Is and How to Avoid It. Nerdwallet. https://www.nerdwallet.com/article/taxes/inheritance-tax

Randolph, Mary, J.D. (n.d.) Estate Planning When You’re Married to a Noncitizen. NOLO. https://www.nolo.com/legal-encyclopedia/estate-planning-when-you-re-married-noncitizen.html