Inheritance Taxes: What Families Need to Know

Inheritance Tax: What You and Your Family Should Know

Attorney Haley Matson

One of the most common questions that we get from new clients is, “what are the tax implications of my estate plan?” While we always try to take the time to explain, there’s often not enough time during a consult or short meeting to fully digest how taxes will affect your estate plan and your beneficiaries. Instead, we can write a full-fledged blog post about it!

There are two major categories of taxes to consider while estate planning. One is the “Estate Tax,” which is paid by your Executor or Administrator out of the total value of the estate. The other is the “Inheritance Tax,” which is paid by your beneficiaries after they receive distributions. There are also implications on filing taxes for certain types of Trusts. To understand these better, we need to go into a bit more detail.

Federal Estate Tax

Federal estate tax is measured by the value of your estate, and is paid by your Executor or Administrator before any distributions go out to your beneficiaries. Your estate’s value will be measured by the total value of all estate assets after any relevant exemptions or deductions. Some of these exemptions and deductions could include:

Marital Deduction: This allows unlimited tax-free transfers to a surviving spouse.
Charitable Deductions: An unlimited amount can be donated to charity to deduct from your overall estate’s value.
Debts and Expenses: Funeral costs, legal costs, payment to the Executor or Administrator, and outstanding medical bills are all deductible from the overall value of the estate.

These estate taxes will begin on any estate value over $13.6 million per person, $27.2 million per married couple. For example, if your estate is worth less than $13.6 million, then the federal estate tax will not apply to any part of your estate. If your estate is worth more than $13.6 million, say, $18.6 million, then you will owe the federal estate tax on the total amount exceeding $13.6 million, which in this case, would be owing federal estate tax on $5 million.

As for the rate of the taxes, federal estate taxes use progressive brackets, much like the federal income tax. The highest bracket is currently 40% at $1 million.

State Estate Tax

North Carolinians rejoice! North Carolina does NOT have a state estate tax. It was repealed in 2013. However, 12 other states and the District of Columbia all have state estate taxes:

Connecticut

District of Columbia

Hawaii

Illinois

Maine

Maryland

Massachusetts

Minnesota

New York

Oregon

Rhode Island

Vermont

The state with the highest exemption amount is Connecticut, with $13.61 million, which resembles the federal estate tax amount. The state with the lowest exemption amount is Oregon, with $1 million. If you live in a state with a state estate tax, be prepared to pay state taxes on any amount exceeding the state estate tax exemption amount, and additional federal estate taxes if your estate’s value exceeds the federal estate tax exemption. These states also use a progressive tax system, with various maximum amounts.

If you are a high net worth individual, it’s worth looking into which states do and do not have state estate tax. Moving to Oregon with a $20 million estate means that you’ll owe federal estate taxes on $7.4 million, and ALSO owe state estate taxes on $19 million!

Inheritance Taxes

Inheritance taxes are paid by the beneficiaries of the estate after distributions. These are the taxes that most clients worry about when they ask if their children or grandchildren will be stuck with a large tax bill. The good news is that only a few states have inheritance taxes. The even better news is that North Carolina is exempt, and does not have inheritance tax! The states who do have inheritance taxes are:

Iowa
Kentucky
Maryland
Nebraska

New Jersey
Pennsylvania

If you do live in a state, or have loved ones in a state with inheritance tax, this is how it would work. Essentially, whatever gets passed down to your beneficiaries will be taxed based on the value of the inheritance they receive and how far removed they are from your family. For example, spouses are completely exempt, children and grandchildren are usually completely exempt from inheritance taxes, except in Pennsylvania, and aunts, uncles, nieces, nephews, and further out will all owe inheritance taxes in those states.

Trust Taxes

Trusts may be a good way to avoid probate, but they may not always be the best for tax purposes. There are two main types of Trusts: the revocable living trust, and the irrevocable trust. Each of these will have different tax implications and consequences.

Revocable living trusts are created by the Grantor, and are controlled by the Grantor for as long as they live. Because of the control, assets in revocable living trusts are considered the Grantor’s assets for all financial and legal purposes. Grantors of revocable living trusts will have to pay taxes on the income from the trust as they would their other individual income. Grantors will declare these on their regular 1040.

Irrevocable trusts are created by the Grantor, but then immediately controlled by a Trustee who is not the Grantor. These trusts are frequently used to plan for long term care, because the assets are completely separated from the Grantor. Since the Trustee controls the assets, the Trustee will be responsible for filing the trust’s taxes. Irrevocable trusts get their own entity identification number and will file a separate tax return on any income coming into the trust. This is form 1041. Any income retained by the trust, such as dividends put back into the trust or interest, will need to be declared on form 1041 by the Trustee.

Beneficiaries who receive income distributions from a revocable living trust will not have to pay taxes. Since the taxes go through the Grantor’s income tax return, the beneficiaries do not owe. Beneficiaries who receive income distributions from an irrevocable trust will have to file a K-1 tax form on the amount received.

Tax brackets for trust income are steep. Any income over $14,450 is taxed at a whopping 37%. Like the other taxes, this uses a progressive bracket system.

Capital Gains Tax

Capital gains tax is also an area of concern. With revocable living trusts, your beneficiaries will get a “step up in cost basis.” This means that the asset inherited will be valued at the fair market value as of the date of death, rather than the value at the time it was originally bought. In Charlotte, this makes a huge difference, as some houses have appreciated more than $500k in value since they were purchased over the years.

Beneficiaries would normally pay capital gains tax on the difference between the value of when the asset was originally obtained and the value of the asset at sale. If you purchased a home for $100k originally, and when you passed it was worth $1 million, your beneficiaries would normally owe around ~$900k in capital gains taxes. With a step up in cost basis, your beneficiaries would pay almost zero capital gains tax, as it would be worth the same.

In irrevocable trusts, however, beneficiaries do not get a step up in cost basis if the Grantor of the trust has completely removed themselves. Instead, they will use the difference in the fair market value at the time the asset was transferred into the trust and the value of the asset at sale. This means that your beneficiaries will more than likely have a large capital gains tax bill.

Plan Smart, Preserve More

Understanding estate and tax planning doesn’t have to be overwhelming. With no estate or inheritance tax in North Carolina, you’re already ahead—but federal taxes, trust rules, and capital gains can still impact your legacy.

Want to ensure your plan protects your assets and loved ones? Schedule a consultation today and get personalized guidance tailored to your unique situation.

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📞 Call us at 1-888-999-6600
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