When you leave your estate to your children, you likely hope the inheritance will benefit them in some way. Perhaps they can invest it, pay off debt, start college funds for their children or simply enjoy the gift you have left them. What you may not realize is that some inheritances involve tax ramifications that may reduce what you had hoped to provide for your loved ones.
Understanding the various taxes your loved ones may face during and after probate may help you decide the most appropriate estate planning tools to take advantage of. There are ways to minimize the tax impact on an investment, but it may take some strategic planning.
The government takes its share
California does not have an estate tax, but the federal government does. That tax affects a very small number of multi-million–dollar estates. If your estate exceeds the threshold for that tax, you would be wise to take steps to lawfully protect your assets. Even if your estate does not qualify for the federal tax, your heirs may still deal with a variety of other taxes because of the windfall from your estate. For example:
- Capital gains tax if they sell any real estate, investments or other valuables they inherit
- Taxes on subsequent earnings, such as rent from a commercial property or interest from an investment you leave to them
- Taxable assets distributed from a retirement account
- Taxes on assets for which you have named an heir as a joint holder, especially assets you have held for a considerable time
Fortunately, there are some ways to reduce the opportunities for the government to take a chunk of your loved one’s inheritances. Often, the most effective way is to place your assets in a trust. Assets you fund to a trust no longer belong to the estate, so they bypass probate and any estate taxes that may otherwise apply. This option is also a recommendation over adding a loved one as a joint owner of an asset.
In some cases, financial advisors recommend distributing your assets before you die. The government allows you to make annual charitable gifts for as much as $15,000 without incurring a tax, and your loved ones may benefit from receiving part of their inheritance now instead of waiting until you pass. However, before taking any of these steps, it is wise to seek sound advice since your estate may have complex and unique factors to consider.
