Understanding Inheritance Taxes
If you have inherited an estate from a loved one, it's important to understand how these assets are likely to be taxed. The amount of federal estate tax that is levied typically is determined by the amount of assets within the estate and the relationship of the heirs to the deceased.
Spouses and Nonspouses
Spouses typically may inherit an unlimited amount of assets free of federal estate taxes. Estates bequeathed to nonspouses, in contrast, may be subject to federal estate taxes and state inheritance taxes depending on the level of assets within the estate.
For nonspousal heirs, estates worth $2 million or less are exempt from federal estate taxes for the 2008 tax year. During 2009, the exemption increases to $3.5 million and in 2010, the federal estate tax is scheduled to disappear temporarily for one year. In 2011, the exemption amount is scheduled to be re-established at $1.1 million. These exemption thresholds were established by Congress, which has the authority to change them in future legislation. Heirs typically may value assets within an estate either at the fair market value on the date of the deceased's death or six months later.
Estates that are worth more than the exemption amounts are subject to federal estate taxes. Currently, the top federal estate tax rate is 45% for 2008 and 2009. Note that many states impose inheritance tax thresholds and tax rates that differ from those at the federal level. An estate planning attorney can advise you on taxation issues in your area.
Special Rules for IRAs
In most instances, spouses who inherit IRAs may treat the IRA as their own and must begin required minimum distributions (RMDs) after age 70 1/2. RMDs, which are taken annually, are taxed as ordinary income.
Nonspouses, in contrast, may not delay RMDs until they reach age 70 1/2. Nonspouses may transfer the IRA assets into an inherited IRA titled specifically for that purpose. When taking distributions, which are taxed as ordinary income, a nonspouse may empty the account over a five-year period. A second option available to a nonspouse is to take annual distributions, with the amount determined by the account balance and the beneficiary's life expectancy. The latter strategy may permit a larger portion of the account to grow tax-deferred.
Inheritance taxes are a complicated issue, and when determining how they apply to your situation, an experienced estate planning lawyer could be your most valuable asset.
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