How Can I Protect My Inheritance From Taxes? (2024)

Key Takeaways

• Inheritances aren't considered income for federal tax purposes, but subsequent earnings on the inherited assets, including interest income and dividends, are taxable (unless it comes from a tax-free source).
• The executor can choose an alternate valuation date (six months after the date of death) if it'll decrease both the gross amount of the estate and the estate tax liability, resulting in a larger inheritance.
• Putting assets in a trust allows you to pass assets to beneficiaries after your death without having to go through probate.
• If one spouse dies, the surviving spouse usually can take over the IRA as their own. If you inherit a traditional IRA from someone other than your spouse, you can transfer the funds to an inherited IRA in your name.

Consider the alternate valuation date

Typically the cost basis of property in a decedent’s estate is the fair market value of the property on the date of death. In some cases, however, the executor might choose the alternate valuation date, which is six months after the date of death.

• The alternate valuation is only available if it will decrease both the gross amount of the estate and the estate tax liability; this will often result in a larger inheritance to the beneficiaries.
• Any property disposed of or sold within that six-month period is valued on the date of the sale.
• If the estate is not subject to estate tax, then the valuation date is the date of death.

Put everything into a trust

If you are expecting an inheritance from parents or other family members, suggest they set up a trust to deal with their assets. A trust allows you to pass assets to beneficiaries after your death without having to go through probate. Trusts are similar to wills, but trusts generally avoid state probate requirements and the associated expenses that wills typically have to go through.

• With a revocable trust, the grantor can take the assets out if necessary.
• An irrevocable trust usually ties up the assets until the grantor dies.

It may be tempting for parents to put their assets into joint names with a child, but this can actually increase the taxes the child pays.

• When joint owner dies, the other owner already owns a portion of of the assets. This means that there is a step up in cost basis on the portion that is inherited but not on the rest of the account.
• For long-held assets, this can mean a significant tax hit when the child sells the asset.

TurboTax Tip:

If your estate is at or close to the taxable amount, consider giving gifts to your beneficiaries while you're still living. You can give up $12.92 million over your lifetime (tax year 2023) without being subject to gift taxes. This amount increase to $13,610 million for 2024.

Minimize retirement account distributions

Inherited retirement assets are not taxable until they’re distributed. However, if the beneficiary is not the spouse, certain rules may apply to when the distributions must occur.

• If one spouse dies, the surviving spouse usually can take over the IRA astheir own. Required minimum distributions would typically begin at age 73, just as they would for the surviving spouse's own retirement accounts.
• If you inherit a traditional IRA from someone other than your spouse, you can transfer the funds to an inherited IRA in your name. You can then decide on a distribution method:
  • Based on your life expectancy
  • Take the money out all at once by the end of the year after the account holder died
  • If the decedent was under age 73 then you also have the option to take out all of the money within 10 years after the year that the account holder died

Give away some of the money

It may seem counter-intuitive, but sometimes it makes sense to give a portion of your inheritance to others. In addition to helping those in need, you could potentially avoid taxable gains on appreciated property and receive a tax deduction bydonating to a charitable organization.

If you're expecting to leave money to people when you die, consider giving annual gifts to your beneficiaries while you're still living. You can give a certain amount to each person—$17,000 for 2023 and $18,000 for 2024—without reducing your lifetime estate tax exemption amount and it doesn't typically require you to file a gift tax return.

Gifting not only provides an immediate benefit to your loved ones, it also reduces the size of your estate, which can be important if you're close to the taxable amount. Talk with an estate planning professional to ensure you're staying current with the frequent changes to estate tax laws.