Are Estate Distributions Taxable?

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Are Estate Distributions Taxable?

In practice, the United States no longer has an inheritance tax. Cash or property inheritances are not taxed as income to the recipient. As of 2021, the estate tax, which is paid by the estate, is payable only on sums above $11.7 million. For 2020, the figure is $11.58 million. Furthermore, a particular clause in the legislation permits the estate of a surviving spouse to receive up to double the exemption. As a consequence, relatively few estates or beneficiaries will have to pay any tax at all.

Key Takeaways

  • Income taxes do not apply to inheritances.
  • The federal estate tax presently only applies to a small number of very rich people, estimated at about 2,000 each year.
  • When the recipient makes withdrawals from an inherited traditional IRA, the income will be taxed.

17 states have an estate or inheritance tax as of 2021. Iowa, Kentucky, Nebraska, New Jersey, and Pennsylvania are the only states with an inheritance tax. However, none of those states tax inheritances to the deceased’s spouse or children. When imposed, the taxes rise to 16% of the inheritance.

A Rare Case When Taxes Are Due

Estates, like individuals, are required to submit income tax returns. They may also owe taxes if the estate’s assets are still producing interest or dividends, for example. If the estate executor does not pay income tax before distributing the inheritance, the recipients may be required to pay some tax.

The estate has the option of paying the taxes owed or distributing the taxable income to the heirs. In other situations, doing so actually saves the recipient money since the estate may be in a higher tax rate than the person getting a portion of the bequest. The inheritance is documented on IRS Form K-1.

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When IRAs Are Involved

While recipients do not owe income tax on money they receive, if their inheritance includes an individual retirement account (IRA), they must take distributions from it over a specific time and pay income tax on that money if it is a regular IRA rather than a Roth IRA. The regulations are explained in Publication 590-B by the IRS.

Why No Estate Tax?

The estate tax has a tumultuous history in the United States. Opponents often referred to it as a “death tax.”

In simpler words, the estate tax was seen as especially unjust to Americans whose family fortunes were invested in real estate rather than cash in the bank. To pay the estate tax, they would be obliged to sell the property. This was seen especially aggravating for family farmers whose money was invested in fields, machinery, and cattle.

Limiting the Tax

In 2010, the federal estate tax was repealed for estates of up to $5 million. In later legislation enacted by Congress, the exemption was confirmed, and the restrictions were increased. Estate taxes are now free up to $11.58 million in 2020 and up to $11.7 million in 2021 under current legislation.

Getting Around the Tax

According to the newest statute, around 2,000 Americans are liable to estate taxes each year, and they often hire accountants who are skilled at avoiding or minimizing the estate tax.

Giving up parts of the estate in advance to family members is one of the more common ways to avoid any estate tax. Another option is to establish an irrevocable life insurance trust.

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