You would like to leave something special to a friend or relative, but you’re worried that your bequest will be a curse, rather than a blessing. Will they have to pay taxes, or will it impact their tax bracket? We discuss three myths involving leaving an inheritance to a loved one.
Myth: Your beneficiaries will be stuck with paying estate taxes on anything you leave them.
Fact: Your estate is subject to federal estate taxes if it exceeds the current Federal estate tax threshold, which is slated to be just $1,000,000 in 2011, and Ohio estate taxes if it exceeds $338,333. The estate pays the estate taxes before property is distributed.
Myth: Your heirs will need to pay income tax on their inheritance.
Fact: Normally the inheritance itself is not taxed, but any income it produces will be. An exception to this generality is a retirement plan like a IRA or 401(k), as withdrawals from the plan are taxed to the heir just as they would have been taxed to the original owner (in many cases, that means taxable as ordinary income).
Myth: If I leave property as an inheritance, and the person sells it, they will pay a huge capital gain tax since I purchased the property 40 years ago for very little money.
Fact: The capital gain or loss on the sale of an inheritance is determined by the “stepped-up basis.” This means that your beneficiary’s investment in inherited property is considered to be the value as of the date of death. When they sell property that is inherited, the capital gain or loss is determined by the difference between the amount they sold it for and the value of the property on the date of death. Remember that not all inherited property may be subject to the stepped-up rule, since it depends upon the type of property and the size of your estate at death.
An estate planning attorney can advise you of the best way to handle leaving a bequest to a loved one, and they can help you ensure that the inheritance truly is a blessing, not a curse.