Estates and beneficiaries can be subject to estate tax, inheritance tax, and income tax.
The Federal Estate Tax is applicable to all estates whose fair market value at the time of death is in excess of $5,250,000 for 2013 (which is indexed for inflation for subsequent years). A history of the estate tax is available here.
The exemption amount amount is reduced for any taxable gifts made during the decedent’s lifetime. In other words, if gifts were made during the life of the decedent, the estate tax could be increased.
Various deductions are available to eliminate taxes on estates over the $5,250,000 threshold. The main deduction is the marital deduction (for assets passing to a surviving spouse). Accordingly, a decedent can leave an unlimited amount to a surviving spouse without the payment of estate tax.
Another common deduction from the estate tax is the charitable deduction. Amount left to charity can therefore be passed without any estate tax.
Individual states can levy an estate tax, in addition to the federal estate tax. Some states have an estate tax with an exemption amount much lower than the federal estate tax figure. It is not uncommon for estates of decedents in one of the states with a lower estate tax exemption amount to owe state estate tax, but not federal estate tax. Florida imposes no state estate tax.
Assets and money received under a will, trust, or by beneficiary designations are often subject to income tax. Most specific gifts under a will are not subject to income tax (such as a gift of a specific amount under a will); however, a gift of a residuary amount from a will or trust will often carry out taxable income. Only the income earned is taxable. The principal amount is not subject to income tax.
For example, if the trust starts with $100,000 and earns $5,000 during the year and then distributes $105,000 to the residuary beneficiary, the beneficiary would owe tax only on the $5,000 of income, at the beneficiary's regular income tax rate.
Some assets are classified as Income in Respect of a Decedent. If a beneficiary receives income that a decedent earned prior to death (such as wages or a retirement account) the beneficiary must include all these amounts as income on their return similar to what the decedent would have.
A beneficiary will often receive a K-1, showing the amount of income that has been passed to the beneficiary as part of the inheritance.
The United States Federal Government does not impose an inheritance tax. Only seven states impose inheritance taxes, although this number is constantly changing. The states that levy inheritance taxes as of 2013 include: Iowa, Kentucky, Maryland, Nebraska, New Jersey and Pennsylvania. Indiana repealed its inheritance taxes as of January 1, 2013. Many foreign countries impose inheritance taxes as well.
An inheritance tax is paid by individuals that receive property as beneficiaries after someone’s death. The beneficiaries of the decedent’s estate are liable for this tax. Most inheritance taxes have exemptions or reduced rates for individuals closely related to the decedent, but the rules vary dramatically from state to state. Most inheritance taxes only apply where the decedent and the beneficiary are in one of the states that levies the inheritance tax, or the decedent owned property in the state that levies the inheritance tax. Florida does not levy an inheritance tax.
The inheritance tax is different, and in addition to, any estate tax that is levied on the estate.
Should you wish to discuss your questions regarding the taxation of an inheritance, estate, or trust, please contact Jeffrey Skatoff at (561) 842-4868.
Written by Jeffrey Skatoff.