Inheritances can be a mixed blessing. Cash can be a welcome infusion during a busy time of life, such as when children are in college. Inheriting property can be emotionally draining and burdensome. Receiving financial assets always prompts questions about taxes.
An experienced estate planning attorney can help you determine how best to structure inheritances for your family members. Some may benefit from staggered payments while others may be concerned about getting bumped into a higher tax bracket.
Understanding Estate Tax and Inheritance Tax
Will your heirs have to pay taxes on money or property that they inherit? It’s unlikely, but there are nuances to understand:
1. The Difference Between Estate Tax and Inheritance Tax
Estate taxes are paid by the estate of the deceased person before assets are distributed to heirs. Inheritance taxes are paid by those who receive an inheritance.
Federal law does not require taxes for inheritances. The federal estate tax is paid by the estate of the deceased and currently only applies to very large estates valued at more than $15 million. States can also impose estate and inheritance taxes.
2. No Illinois Inheritance Tax
The State of Illinois does not collect an inheritance tax on money or property inherited by family members. However, if you inherit money from someone who lived in a state with an inheritance tax, you may owe a portion to that state. Inheritance tax law is based on the location where the deceased resided, not where the heir resides.
3. Illinois State Estate Tax
Illinois does collect an estate tax under certain circumstances. It is a tax paid by the estate before heirs receive their shares—if the estate assets exceed a specific amount. The state tax exemption is $4 million, so estates of $4 million or above pay taxes which range from 0.8 percent to 16 percent, depending upon the value of the estate.
4. Other Taxes That Apply to Inheritances
Inheriting a retirement account, such as an IRA or 401(k) does not automatically require tax payments but when distributions are taken, income taxes apply.
In addition, after selling property that was inherited, capital gains taxes apply. However, under the “step-up in basis” rule, capital gains are reduced when inherited assets like stocks or real estate are assigned a tax basis equal to their value at the owner’s death.
5. Comparisons With Other States
Those who own property in multiple states may need to know how those states treat inheritances and estates. The following are examples:
- No estate or inheritance taxes: Florida, Texas, and Nevada do not impose these taxes.
- Estate tax only: New York and Massachusetts tax estates valued above a certain threshold but do not impose inheritance taxes.
- States with inheritance taxes: Nebraska, Pennsylvania, and Kentucky collect taxes from those who receive inheritances, but the percentage varies according to the relationship between the heir and the deceased.
6. Next Steps for Planning
Tax planning is a necessary part of assembling your estate. Your children won’t pay inheritance taxes today but laws can change. That’s why it’s important to work with a professional and to take the following steps:
- Review wills and beneficiaries regularly.
- Consider adding gifts and trusts to your estate plan to reduce the impact of taxes and streamline the asset transfer process.
Good planning can help ensure your children receive as much of your legacy as possible — without unexpected tax surprises.
Help With Planning Your Estate and Future Taxes
An estate planning attorney from Legacy & Life Law Firm can guide you through the process of setting up the next generation to receive inheritances without sacrificing a large portion to taxes. A well executed estate plan can preserve your legacy and provide for your heirs. Call for a consultation today.