Death and Taxes

Death and Taxes are two certainties in life. When they collide, the results can be disastrous without careful consideration and planning. The good news is that most inheritances are passed on free of tax. However, a misstep could cost you dearly with the IRS depending on the size of the estate and the type of asset. 

The first type of tax people usually think about with inheritances is the “death tax,” more officially known as the estate tax. This is a transfer tax, meaning it is a tax on the assets you are giving away at your passing. If you give away less than the estate tax exemption amount, there is no estate tax. Currently, the exemption amount is very high – $11.7 million per person. 

The exemption amount is scheduled to half in 2026 if Congress doesn’t change it before then which seems more likely with the current administration. Democrats have already signaled that they want to lower the estate tax exemption amount, by how much is unclear, but probably to around $5-7 million per person.

If your assets exceed the estate tax exemption amount, then planning is critical to avoid or greatly reduce any estate tax liability. Some steps you can take now are to set up a revocable living trust and gift assets at a discount under the guidance of an attorney versed in estate tax planning. I strongly advise using a professional for this type of planning as it can be very complex.

For people who inherit retirement accounts (IRA, 401k, etc…), not checking the right box on a claim form can cost you dearly. You have three options when you inherit a retirement account, you can take all the money at one time or deferred over 5 or 10 years. If you take all the money out at one time, rather than defer for 5 or 10 years, it will all be treated as income for that year significantly raising your tax liability.

A common mistake I see with retirement accounts is having your trust named as the beneficiary and not individuals. Oftentimes, this doesn’t allow the beneficiaries to opt for 10-year deferral and all the money has to come out at once or over 5 years. If you have minor or special needs beneficiaries, then naming a trust as beneficiary may be your best option, but careful planning is needed to make sure your trust will have a good chance of allowing the maximum deferral period. 

Warrant Buffett once said “[s]omeone’s sitting in the shade today because someone planted a tree a long time ago.” If you want to make sure the IRS doesn’t chop some of your tree down, then don’t procrastinate setting up your estate plan. And if you’ve recently inherited a retirement account, make sure to check the right box!