How Can I Protect My Inheritance From Taxes? (2024)

Received an inheritance of cash, investments, or property? Here are four ways that can help you keep it from being swallowed up by taxes.

How Can I Protect My Inheritance From Taxes? (1)

Key Takeaways

  • Inheritances aren't considered income for federal tax purposes, but subsequent earnings on the inherited assets, including interest income and dividends, are taxable (unless it comes from a tax-free source).
  • The executor can choose an alternate valuation date (six months after the date of death) if it'll decrease both the gross amount of the estate and the estate tax liability, resulting in a larger inheritance.
  • Putting assets in a trust allows you to pass assets to beneficiaries after your death without having to go through probate.
  • If one spouse dies, the surviving spouse usually can take over the IRA as their own. If you inherit a traditional IRA from someone other than your spouse, you can transfer the funds to an inherited IRA in your name.

Do I have to report my inheritance on my tax return?

In general, any inheritance you receive does not need to be reported to the IRS. You typically don’t need to report inheritance money to the IRS because inheritances aren’t considered taxable income by the federal government.

That said, earnings made off of the inheritance may need to be reported.

Is your my inheritance taxed by the federal or state government?

The federal government doesn’t impose an inheritance tax, but certain states do. As of 2023, the following six states have an inheritance tax in place:

  • Iowa
  • Kentucky
  • Maryland
  • Nebraska
  • New Jersey
  • Pennsylvania

While the federal government doesn’t have an inheritance tax, it does have an estate tax. The federal estate tax is imposed on the assets of the deceased and can be impacted by assets such as real estate, cash, insurance, securities, business interests, and more.

As opposed to a state inheritance tax, which is levied against the inheritors, an estate tax is levied against the taxable estate of the deceased. It’s important to note that, in addition to the federal estate tax, several states levy their own estate tax as well.

How much money can I inherit before you have to pay taxes on it?

In states with an inheritance tax, the amount being distributed to inheritors will typically have to reach a certain threshold for the inheritance tax to apply.

The exact inheritance amount threshold varies from state to state and inheritors may be able to take advantage of more state-level exemptions depending on their relationship to the deceased and other factors.

While the federal government doesn’t impose an inheritance tax, the IRS does have a threshold for the federal estate tax. This threshold gradually rises every year to account for inflation over time. As of 2023, your estate is required to pay the federal estate tax if the value of your taxable estate exceeds $12.92 million and increases to $13,610,000 for 2024.

How can I avoid paying taxes on my inheritance?

Inheritances are not considered income for federal tax purposes, whether you inherit cash, investments or property. However, any subsequent earnings on the inherited assets are taxable, unless it comes from a tax-free source. You will have to include the interest income from inherited cash and dividends on inherited stocks or mutual fundsin your reported income. For example:

  • Any gains when you sell inherited investments or property are generally taxable, but you can usually also claim losses on these sales.
  • State taxes on inheritances vary; check your state's department of revenue, treasury or taxation for details, or contact a tax professional.

Consider the alternate valuation date

Typically the cost basis of property in a decedent’s estate is the fair market value of the property on the date of death. In some cases, however, the executor might choose the alternate valuation date, which is six months after the date of death.

  • The alternate valuation is only available if it will decrease both the gross amount of the estate and the estate tax liability; this will often result in a larger inheritance to the beneficiaries.
  • Any property disposed of or sold within that six-month period is valued on the date of the sale.
  • If the estate is not subject to estate tax, then the valuation date is the date of death.

Put everything into a trust

If you are expecting an inheritance from parents or other family members, suggest they set up a trust to deal with their assets. A trust allows you to pass assets to beneficiaries after your death without having to go through probate. Trusts are similar to wills, but trusts generally avoid state probate requirements and the associated expenses that wills typically have to go through.

  • With a revocable trust, the grantor can take the assets out if necessary.
  • An irrevocable trust usually ties up the assets until the grantor dies.

It may be tempting for parents to put their assets into joint names with a child, but this can actually increase the taxes the child pays.

  • When joint owner dies, the other owner already owns a portion of of the assets. This means that there is a step up in cost basis on the portion that is inherited but not on the rest of the account.
  • For long-held assets, this can mean a significant tax hit when the child sells the asset.

TurboTax Tip:

If your estate is at or close to the taxable amount, consider giving gifts to your beneficiaries while you're still living. You can give up $12.92 million over your lifetime (tax year 2023) without being subject to gift taxes. This amount increase to $13,610 million for 2024.

Minimize retirement account distributions

Inherited retirement assets are not taxable until they’re distributed. However, if the beneficiary is not the spouse, certain rules may apply to when the distributions must occur.

  • If one spouse dies, the surviving spouse usually can take over the IRA astheir own. Required minimum distributions would typically begin at age 73, just as they would for the surviving spouse's own retirement accounts.
  • If you inherit a traditional IRA from someone other than your spouse, you can transfer the funds to an inherited IRA in your name. You can then decide on a distribution method:
    • Based on your life expectancy
    • Take the money out all at once by the end of the year after the account holder died
    • If the decedent was under age 73 then you also have the option to take out all of the money within 10 years after the year that the account holder died

Give away some of the money

It may seem counter-intuitive, but sometimes it makes sense to give a portion of your inheritance to others. In addition to helping those in need, you could potentially avoid taxable gains on appreciated property and receive a tax deduction bydonating to a charitable organization.

If you're expecting to leave money to people when you die, consider giving annual gifts to your beneficiaries while you're still living. You can give a certain amount to each person—$17,000 for 2023 and $18,000 for 2024—without reducing your lifetime estate tax exemption amount and it doesn't typically require you to file a gift tax return.

Gifting not only provides an immediate benefit to your loved ones, it also reduces the size of your estate, which can be important if you're close to the taxable amount. Talk with an estate planning professional to ensure you're staying current with the frequent changes to estate tax laws.

With TurboTax Live Full Service, a local expert matched to your unique situation will do your taxes for you start to finish. Or, get unlimited help and advice from tax experts while you do your taxes with TurboTax Live Assisted.

And if you want to file your own taxes, you can still feel confident you'll do them right with TurboTax as we guide you step by step. No matter which way you file, we guarantee 100% accuracy and your maximum refund.

How Can I Protect My Inheritance From Taxes? (2024)

FAQs

How to shield inheritance from taxes? ›

  1. How can I avoid paying taxes on my inheritance?
  2. Consider the alternate valuation date.
  3. Put everything into a trust.
  4. Minimize retirement account distributions.
  5. Give away some of the money.
Jan 12, 2024

How do I protect my inheritance? ›

Protect your inheritance received during the marriage
  1. still document and keep proof that you received an inheritance;
  2. open a separate account, in your sole name, for the inheritance;
  3. keep proof that you deposited the inheritance into the account;
  4. do not use the inheritance to buy jointly owned assets with your spouse;
Mar 2, 2023

Can IRS touch inheritance? ›

Can IRS seize inherited property? Yes, the IRS can seize inherited property for unpaid taxes after following their standard process of notices. Can the IRS take inheritance money? Yes, the IRS can take inheritance money for unpaid taxes.

What type of trust avoids all taxes? ›

A residence trust is another form of irrevocable trust because only irrevocable trusts can shield assets from estate taxes.

How much can you inherit without paying federal taxes? ›

In 2024, the first $13,610,000 of an estate is exempt from the estate tax. A beneficiary may also have to pay capital gains taxes if they sell assets they've inherited, including stocks, real estate or valuables. The federal capital gains tax ranges from 15% to 20%, depending on your tax bracket.

What is the best trust to avoid estate taxes? ›

One type of trust that helps protect assets is an intentionally defective grantor trust (IDGT). Any assets or funds put into an IDGT aren't taxable to the grantor (owner) for gift, estate, generation-skipping transfer tax, or trust purposes.

Can you protect inheritance money? ›

The best method for parents to structure a wealth transfer to protect their child's inheritance is via a trust. One efective way to shield your family's wealth — whether from things like divorce or from anyone who may try to take advantage of them — is through a trust with a corporate trustee to oversee it.

Does inheritance count as income? ›

Inheritances are not considered income for federal tax purposes, whether the individual inherits cash, investments or property.

Do I need to report inheritance to the IRS? ›

If you are a beneficiary of property or income from the estate, you could be impacted on your federal income tax return. You must report any income you receive passed through from the estate to you and reported on a Schedule K-1 (1041) on your income tax return.

How do I deposit a large cash inheritance? ›

A good place to deposit a large cash inheritance, at least for the short term, would be a federally insured bank or credit union. Your money won't earn much in the way of interest, but as long as you stay under the legal limits, it will be safe until you decide what to do with it.

What assets can the IRS not touch? ›

There are only a few types of assets that cannot be seized. The IRS cannot seize real property, and your car cannot be seized if used to get to and from work. You also cannot seize the money you need for basic living expenses. However, all of your other assets are fair game for seizure.

What is considered a large inheritance? ›

Inheriting $100,000 or more is often considered sizable. This sum of money is significant, and it's essential to manage it wisely to meet your financial goals. A wealth manager or financial advisor can help you navigate how to approach this.

What is the best trust to minimize taxes? ›

A credit-shelter trust offers a way for you to pass on your estate and lower estate taxes. Under a credit-shelter trust, your surviving heirs would not receive your property (which would then be subject to an estate tax). Instead, your heirs would receive an interest in the trust itself.

What is the best type of trust to protect assets? ›

Irrevocable trusts

This can give you greater protection from creditors and estate taxes. As stated above, you can set up your will or revocable trust to automatically create irrevocable trusts at the time of your death.

How do the rich use trusts to avoid taxes? ›

You can transfer assets to the trust while getting an annuity payment. If the assets in the trust appreciate enough, you can pass that excess value to your heirs with little or no tax. GRATs are a popular wealth transfer strategy with ultra-wealthy Americans.

Is there any way around inheritance tax? ›

Avoid inheritance tax by using trusts

You can put assets into a trust for someone, to take them outside your estate and so reduce the inheritance payable on them or avoid inheritance tax completely.

How do rich families avoid inheritance tax? ›

Buying offshore life insurance policies. Private-placement life insurance, or PPLI, can be used to pass on assets from stocks to yachts to heirs without incurring any estate tax. In short, an attorney sets up a trust for a wealthy client. The trust owns the life-insurance policy that's created offshore.

What triggers inheritance tax? ›

Once the executor of the estate has divided up the assets and distributed them to the beneficiaries, the inheritance tax can come into play. The amount of tax is calculated separately for each individual beneficiary, and the beneficiary has to pay the tax.

Do you have to pay taxes on money you receive as a beneficiary? ›

Generally, beneficiaries do not pay income tax on money or property that they inherit, but there are exceptions for retirement accounts, life insurance proceeds, and savings bond interest. Money inherited from a 401(k), 403(b), or IRA is taxable if that money was tax deductible when it was contributed.

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