Any estate planning attorney in Palm Desert can quickly confirm that a large inheritance may easily be devoured by state or federal taxes. Although this does not happen in all cases, there are certain times where the worth of an estate is considerably decreased due to tax penalties. Fortunately, if you feel your inheritance is at risk, you can work with your parent or the person from whom you will inherit on ways to significantly lessen the tax bite. Below are some tips on how to avoid having your inheritance consumed by taxes:
Strategic use of Gifts
One individual making a gift to someone else pays a gift tax at the federal level. However, the Internal Revenue Service allows individuals to make gifts of up to $13,000 annually without paying gift taxes. Therefore, if your benefactor gives you $130,000 of your future inheritance, neither of you are obligated to pay federal tax on the money. If this is done for ten consecutive years, the benefactor has trimmed down the estate by approximately $130,000. If you are comfortable speaking to your benefactor on this topic, ask about the possibility of utilizing this approach to protect your inheritance.
Using a Trust
If you know you are inheriting a sizable amount of money or assets from a family member, suggest that the person establish a trust in advance. This allows you to pass assets to beneficiaries after you die. Trusts are somewhat similar to last will and testaments, but the primary advantage is that trusts typically avoid state probate and other expenses associated with receiving an inheritance. There are revocable and irrevocable trusts. If a revocable trust is used, the grantor has access to the assets if they are needed. However, irrevocable trusts generally tie up the assets until the death of the grantor.
Change the Valuation Date
You may also wish to consider an alternative valuation date. In most cases, property in a decedent’s estate is based on the property’s fair market at the time of the person’s death. However, in certain instances, the executor may decide to select a different valuation date, such as six months following his or her death. This option is only viable if it decreases both the estate tax liability and the gross amount of the estate, which results in a larger inheritance for the beneficiaries. All property sold or disposed of during the six month period is valued at the time of the sale.
Reduce Retirement Account Distributions
Inherited retirement assets are taxed at distribution. For this reason, if you will be inheriting a retirement account from anyone other than a spouse, the funds can be transferred in your name to an inherited IRA. You are required to take minimum distributions beginning the year of or the year following your inheritance being received, even if you have not yet reached the age of 70 1/2. If the person from whom you inherited the IRA was older than you at the time of his or her death, you should consider opting for the “single life” calculation method concerning the required distribution amount. Your minimum distributions are smaller because this option can be based on age. This ultimately means less tax liability because the funds can grow tax-deferred for a longer period.
Disclaiming the Inheritance
Finally, you may choose to use a somewhat drastic step, although a highly effective one, to avoid excessive taxation. This is called “disclaiming,” and involves turning down your inheritance in lieu of passing it on to the next heir in line. For example, if you have children and are financially secure, disclaiming the estate and allowing a son or daughter to inherit may result in a much lower tax rate. If you know you will be receiving an inheritance in the future, consider discussing these and other options with an estate planning attorney in Palm Desert to ensure the best possible results.