Your Guide to Paying Inheritance Tax

Inheriting assets or property when a loved one passes away can have a positive impact on your household. Yet, it can be a difficult time since you are dealing with your loss concurrently. Take the time needed to process the loss before making major decisions; however, don’t delay in gaining an understanding of the tax implications as a result of your inheritance.

Tax on inheritance is an area that most people aren’t knowledgeable about. And, you don’t need to be until you are the recipient of inherited assets. Tax laws regarding inheritances can be complicated and somewhat intimidating, leaving you with uncertainty in terms of where to go for information.

The good news is that most people don’t need to worry about a tax on inheritance such as estate taxes, but there are other factors you should consider. To help you better understand how to reduce your tax on inheritance (or minimize taxes your loved ones pay when preparing a will), our tax consultants in Raleigh and Durham are outlining exactly what inheritance tax is as it relates to trusts, gifts, estates, property, and capital gains.

In this article, the CPAs from Steward Ingram, and Cooper, PLLC explore various scenarios and provide valuable insights to help you understand what various taxes on inheritance are, whether tax might be due on your inheritance, and, if so, how much. 

What is Tax on Inheritance?

Tax on inheritance, or more simply, inheritance tax, is a tax on money or property that you inherit imposed by some states. It is a state tax, not a federal tax. Inheritances are not considered income for federal tax purposes. Inheritance tax is levied on the assets from a deceased person’s estate that are received by an individual. Automobiles, property, and investments are included in the inherited assets that have a tax imposed. The recipient of the assets is responsible for paying the tax. Generally, the value of the inherited assets has to exceed a minimum amount before an inheritance tax is due.

As of 2023, six states have inheritance tax: Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. The inheritance tax is assessed by the state(s) in which the inheritor lives.

Is Tax on Inheritance Different from Estate Tax?

A tax on inheritance is not the same as an estate tax. An estate tax is levied on the estate before its assets are distributed, whereas an inheritance tax (where applicable) is imposed on the deceased’s beneficiaries after assets are distributed. The federal government taxes large estates directly but does not charge inheritance tax on those who receive assets from an estate. An estate can have estate taxes charged and income tax on earnings from the estate. Estate taxes are irrelevant to inheritance taxes. Through estate planning, you can employ strategies to reduce the amount of taxes owed on an estate.

How is Tax on Inheritance Calculated?

Understanding how tax on inheritance is calculated and when it comes into play is important for estate planning as well as for those who stand to inherit. If an inheritance tax is due, it is applied only to the part of an inheritance that exceeds an exemption amount. When the exemption amount is exceeded, the tax is typically assessed on a sliding basis.

Tax on Inheritance in NC

There is no inheritance tax in North Carolina. This means that beneficiaries are not required to pay tax on assets they inherit.

However, there are other tax considerations to keep in mind:

• Estate Tax: North Carolina repealed its estate tax in 2013. Therefore, there is no state estate tax to be concerned with for deaths occurring after January 1, 2013. Estates of North Carolina residents and nonresidents who own property in North Carolina are subject to this rule.
• Federal Estate Tax: While North Carolina does not have a state estate tax, large estates might still be subject to the federal estate tax. Estates valued above a certain threshold (which is adjusted annually for inflation) may be liable for federal estate tax. In 2023, the federal estate tax ranged from 18-40% and applies to assets valued at $12,920,000 for an individual. Recently, the IRS announced an increased Federal Estate Tax Exemption for 2024 of $13,610,000 per individual.
• Income Tax on Inherited Assets: While there’s no inheritance tax per se, beneficiaries may still face income tax implications. For instance, if you inherit a retirement account or other income-generating asset, any income received from these assets might be subject to federal and state income tax.
• Property Tax: Inheriting real estate in North Carolina means taking over the responsibility for property taxes on that real estate. The value of the property at the time of the decedent’s death is typically used for tax purposes.
• No Inheritance Tax for Beneficiaries: It’s key to reiterate that beneficiaries in North Carolina do not pay a specific tax just for receiving an inheritance, regardless of their relationship to the deceased.

Understanding Trusts and Taxes

Revocable Trusts

Revocable trusts do not typically provide tax advantages when it comes to inheritance tax. Since the grantor can alter the trust, the assets are still considered part of their estate.

Irrevocable Trusts

Irrevocable trusts may offer tax benefits. Once assets are placed in an irrevocable trust, they are no longer considered part of the grantor’s estate, which can potentially reduce the tax liability.

What is a Gift Tax and Does North Carolina Have One?

As stated earlier, an inheritance tax is a tax on the assets received from someone’s estate after they pass away. Gift tax, on the other hand, is potentially applicable to gifts given during a person’s lifetime. North Carolina does not have a gift tax. However, you may be assessed a gift tax at the federal level depending on the value of the gifts you provide. You don’t owe a gift tax until you exceed your lifetime gift and estate tax exemption, which is $13.61 million for 2024.

Federal Annual Gift Tax Exclusion

You can provide a certain amount to each individual without paying any tax on the gift. The current annual gift exclusion for 2023 is $17,000 and has been increased for 2024 to $18,000.

If you happen to exceed the annual amount, you don’t need to worry. Our CPAs will help you in preparing the necessary paperwork to report the gifts that went above the limit. The IRS requires certain tax forms to keep up with the lifetime gift and estate tax exemption.

Annual Gift and Estate Tax Exemption

The annual gift and estate tax exemption is the value of the gifts (in dollars) that you can give away in your lifetime before you must pay an actual gift tax to the U.S. government. The amount can vary from year to year. The annual exclusion is the amount allowed each year without having to report it. When you exceed that amount in any given year, you go into the lifetime exemption.

Here is an example. If you give away $40,000 to one person in 2024, you have gone over the annual exclusion amount by $22,000. Let’s assume this is the first time you have exceeded the annual amount allowed. Now, you have to subtract that overage amount from your lifetime exemption. This calculation looks like this: $13.61 million – $22,000 = $13.588 million. The result is the amount you have left to give away in your lifetime before paying taxes.

If the gift tax is applied at some point, the rate can be 40%. The rate depends on how much of the money exceeds your lifetime exemption.

Inheritance Tax on Property 

An inheritance tax on property is a tax that may be levied on individuals who inherit real estate or other property from a deceased person. The rules and rates for inheritance tax can vary significantly depending on the jurisdiction. Individuals who inherit property in North Carolina, whether it’s real estate or other types of property, are not required to pay a tax on inheritance to the state.

Federal Taxes on Property Inheritance

While there is no state-level inheritance tax in North Carolina, other tax considerations may still apply, such as federal estate taxes for very large estates. The federal estate tax applies to the entire estate before the assets are distributed to the beneficiaries and only affects estates that exceed a significant exemption threshold, which was $12,920,000 per individual as of 2023 and will increase to $13,610,000 in 2024.

Capital Gains Taxes

The IRS applies a stepped-up basis to the property asset you inherit. This means that the base price of the asset is reset to its value on the day that you inherit it. By stepping up the cost basis, it is rare for heirs to pay significant taxes on inherited property.

For example:

• Let’s say that you inherit property from your grandparents and sell it immediately. Then you would owe no taxes on that asset. If a house was purchased by the decedent for $100,000 and it is worth $300,000 the day you inherit it, there is an appreciation of $200,000. At the moment you inherit it, even though the house has appreciated while your grandparents owned it, the IRS considers the house’s original cost basis stepped up to the current market value ($300,000).
• Now, let’s say you hold the house for a year and the price of the house goes up to $400,000 (+$100,00). When you sell the house, you owe taxes on the increase of $100,000 that occurred during the year you held it.

What is the Estate Tax?

The estate tax is a federal tax that is applied to a person’s assets after their death. This tax is assessed on the fair market value of the assets at the date of death. Assets that are inherited by a surviving spouse are not subject to the federal estate tax because of the unlimited marital deduction.

However, any estate that is worth less than $13.61 million is exempt from the tax in 2024. For estates valued over that amount, the estate tax is paid before any inheritance is distributed or disbursed, so while beneficiaries may not receive a full amount, they will not have to pay a separate tax on it. 

The estate tax ranges between 18 and 40 percent and is dependent on the value of the estate over the exemption limit. For example, if the estate is worth $9,999 more than the exemption, an 18 percent tax will be levied only against the $9,999. However, assets totaling $14.61 million would have $1 million taxed at 40 percent. 

To minimize the amount of tax due on your estate after your death, consider these options: 

How to Reduce Estate Taxes

• Spend it before your passing
• Provide monetary gifts below the gift tax threshold
• Leave it to a qualified charitable organization
• Create a trust for your heirs and beneficiaries

Tax on Inherited IRAs

Sometimes inherited assets are in the form of an IRA that the decedent owned. Inheriting an IRA can be complex because of the tax rules that govern these retirement instruments. There are three main types of beneficiaries for a retirement account:

• Designated beneficiary
• Eligible designated beneficiary
• Beneficiary through a will or estate

An inherited IRA may be taxable depending on the type. If you inherit a Roth IRA, there is no tax due. If you inherit a traditional IRA, any amount you withdraw is subject to ordinary income taxes. For estates subject to the estate tax, inheritors of an IRA get an income-tax deduction for the estate taxes paid on the account. The taxable income earned is called “income in respect of a decedent.” Whenever you take a distribution from an IRA, it is taxable income. However, if the deceased’s estate paid a federal estate tax, the beneficiary gets an income tax deduction for the estate taxes that were paid on the IRA. So, there is no inheritance tax on the IRA, but there is income tax that may be due.

Protect Your Tax on Inheritance and Estates with a Tax Accountant Today

To help minimize the taxes your estate or your beneficiaries will owe, reach out to our CPA firm today. Our Raleigh and Durham CPAs are dedicated to helping our clients create advantageous and ethical strategies to minimize tax payments and help you keep more of your income and property. 

Schedule a consultation to sit down with an accountant today at  (919) 872-0866 or fill out the form below to get started.