One wrong move could mean that the IRS takes a bigger bite out of the money your departed friend or family member left to you.
By Jason Notte, TheStreet
Losing a person in your life is difficult enough without having to figure out how to hold on to what the dearly departed left you.
The tax season brings more worries for those who’ve lost a friend or loved one and have received an inheritance. That last gift from Mom, Dad, the grandparents or anyone else in your circle can be a touching gift, but heirs might unknowingly incur some serious tax penalties.
Estate tax and inheritance tax laws written in Washington and state capitals can take a big bite of what’s left behind, but they don’t have to.
“Don’t feel like you need to be in a rush to make an investment decision after a person passes away,” says Chris Hobart, the CEO and founder of Hobart Financial Group in North Carolina. “You’re in a rush and don’t know all the rules, then all of a sudden you realize you owe taxes on all this money after you’ve bought a car or bought a pool.”
Does your state tax inheritances?
The process of claiming an inheritance is a tangle of qualified and nonqualified money, state and federal taxes, estate and inheritance taxes and the thresholds and loopholes for each. An unknowing or unwitting heir who has come into some money suddenly has to cope not only with the loss, but also with a series of inheritance and estate laws that Jonathan Bergman, vice president of Palisades Hudson Financial Group in Scarsdale, N.Y., calls “a minefield.”
With the tax-filing deadline fast approaching, Hobart and Bergman offer the following advice to heirs struggling to figure out how much, if anything, they owe the state or Internal Revenue Service before settling their affairs:
1. Take inventory
When President Barack Obama and Congress passed the Tax Relief Act of 2010, it not only extended the Bush tax cuts but implemented a federal estate tax that bumped up the exclusion from $1 million to $5.1 million while dialing down the tax rate on funds beyond that threshold to 35% from 45%.
Heirs who think they’re under that $5.1 million mark based on their best guess of what the combination of the estate’s cash and property is worth really should hold off on earmarking that cash for the beach house or kids’ college fund. Nothing’s certain until the formal appraisal takes place.
“When you inherit something, generally the cost basis of the security is equivalent to the fair-market value on the date of death,” Bergman says. “In certain instances, there may be an alternate valuation date six months after the date of death, but that would be determined by the personal representative of the decedent.”
Even those assets may not be the whole picture. Hobart warns that life insurance policies the heirs aren’t aware of can still bump them over the limit.
“People think life insurance is tax-free and that’s great, but if the life insurance pays into the estate and not into an irrevocable life insurance trust, that counts toward the $5.12 million threshold,” Hobart says. “Let’s say that Mom and Dad had $1 million in assets, but they went crazy and got a $9 million life insurance policy; that estate is now worth $10 million and falls under federal estate-tax exemption.”
Staying under the $5.1 million threshold doesn’t necessarily ward off the estate tax, either. Uncle Sam may not get out of bed for less than $5.1 million, but 16 states and the District of Columbia certainly do. Connecticut, Delaware, Hawaii, Illinois, Maine, Maryland, Massachusetts, Minnesota, New Jersey, New York, Ohio, Oregon, Rhode Island, Tennessee, Vermont and Washington all impose state estate taxes of up to 35% for those worth more than a specified amount. That ceiling is as high as the fed-matching $5.1 million in North Carolina, but dips as low as $675,000 in New Jersey or $338,333 in Ohio.
Reprinted from MSN Money