Avoiding Potentially Costly Inheritance Tax Mistakes
Inheritance tax planning


Death and taxes are life’s two inevitabilities. Unfortunately, taxes — in the form of inheritance taxes — can still haunt your heirs even after your passing.

Of course, living trusts are an excellent means to pass much of your estate to your heirs essentially tax-free.

But not all of your probable assets are covered by a living trust. And certain assets have potentially significant tax consequences to receiving heirs, while others have little to no tax liabilities.

Here are some essential factors to keep in mind when allocating assets as you prepare your last will and testament.

The SECURE Act Took a Bite Out of Inherited Retirement Accounts

Prior to 2020, if an heir inherited an IRA (or another tax-deferred account, including a 401(k) plan), they could transfer the money into an account called an inherited, or “stretch,” IRA. And they could make withdrawals throughout the remainder of their life. Such withdrawals are taxed at the ordinary income tax rates, and in the meantime, funds remaining in the account could continue to accrue interest.

After passage of the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019, adult children and heirs (other than spouses) who inherit an IRA after January 1, 2020, can either take a lump sum or transfer the money to an inherited IRA, from which the funds must be withdrawn entirely within 10 years of the granter’s death.

Let’s consider a scenario. Say you have $3 million in a tax-deferred retirement account, and you pass that along to a son, a successful doctor in private practice. Your son is in a higher income tax bracket because of his earnings has a doctor and will now be taxed on every dollar he withdraws from your retirement account.

And in high-tax states like California, this likely means your son will pay out nearly half of the inherited funds in taxes.

How “Stepped Up Basis” Can Help

Let’s reimagine the scenario above with your supposed doctor’s son. But instead of inheriting $3 million from your tax-deferred retirement accounts, he inherits $3 million from your brokerage account.

Thanks to the Stepped Up Basis provision that governs most other inherited assets, your son could dispose of your assets with zero inheritance tax liability. The value of assets, such as stocks + securities, business investment holdings, and real estate, are “stepping up” to their current assessed value at the time of the grantor’s passing.

That means if you bought Apple stock in the pre-iPhone era, which ballooned to $1 million in value, it has “stepped” up to its current value. Thus, your heirs could immediately sell the stock and pay no capital gains taxes.

As already mentioned, Stepped Up Basis also applies to real estate. But with real estate and the other noted assets, if you hold on to them and their value grows, you’re responsible for paying taxes for increases gained above their reset value.

Have More Questions About Inheritance Taxes?

Speculating on what might happen after you die can be a grim prospect. But when it comes to ensuring your loved ones see the bulk of your estate land in their pockets rather than government coffers, it’s a worthy undertaking.

If you have questions about estate tax planning — Get in touch for a FREE consultation!


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