Is my inheritance subject to tax?  For most of our clients, the answer to this question is generally “no.”  However, it is helpful to know the potential forms of taxation when assets are transferred from the decedent to a beneficiary to better understand why this is the case.

Estate Tax

An estate tax is a transfer tax imposed on the entire “portfolio” of an individual at the individual’s death.  Individuals with high net worth may be subject to the Federal Estate Tax.  The first $12.06 million (in 2022) of the “portfolio” is exempt from federal estate tax.  The estate tax is “portable” between spouses.  This means that in a married couple situation, if the first spouse does not use his or her entire $12.06 million exemption, the estate of the surviving spouse may use the remainder (provided the surviving spouse makes an “election” on the first spouse’s estate tax return).  Consequently, a husband and wife would have no estate tax if their estate is less than $24.12 million.

The Indiana Estate Tax is what is commonly referred to as a “pick up” tax.  This means that Indiana picks up all or a portion of the credit for state death taxes allowed on the federal estate tax return.  A federal credit for state estate taxes no longer exists; so, no Indiana estate tax is currently in effect.

Inheritance Tax

An inheritance tax is a transfer tax levied on individuals who receive property in excess of their exemption.  Indiana repealed its inheritance tax in 2012.

Decedent’s Personal Income Tax

Income tax owed by the decedent on income earned prior to the decedent’s death must be paid by his or her estate.

Estate Income Tax

The estate may also have to file an income tax return to report income earned by estate assets during the administration of the estate.

Beneficiary Income Tax

To the extent that the estate distributes income to a beneficiary, the beneficiary will report that income on his or her individual income tax return.  The amount distributed will be indicated on a form “K-1” that the Personal Representative will send to the beneficiary.  It is important to note that while the beneficiary may pay income tax on his or her share of income earned by the estate, the principal value of the asset is not subject to tax.  So, for example, if a beneficiary receives a $100,000 piece of real estate from the decedent, the beneficiary would pay income tax on any rent received on the real estate during the administration of the estate, but would not pay income tax on the value of real estate received.

Besides estate income tax, if a beneficiary receives an asset that realizes income after the death of the decedent, the beneficiary would pay income tax on the amount realized.  For example, if the decedent owned an annuity that contained a portion of earnings which the decedent had not paid tax, the beneficiary would have to pay income tax on the deferred portion of the earnings when the beneficiary receives a distribution from the annuity.

Receiving an Inheritance While on Medicaid

For most people, receiving an inheritance is something good, but for a nursing home resident on Medicaid, an inheritance may not be such welcome news. Medicaid has strict income and resource limits, so an inheritance can make a Medicaid recipient ineligible for benefits that pay for their care. Careful planning is necessary to make sure the inheritance doesn’t have a negative impact.

Reporting Inheritance Money as Income

An inheritance will be counted as income in the month it is received. You or whoever is representing you will have to inform the state Medicaid agency, and coverage will end until you have spent down assets to the countable limit again, which is $2,000 in most states. If you receive an inheritance and the amount puts you over the income limits for your state, you will not be eligible for Medicaid for that month. If you can properly spend down the money in the same month it is received, you will be eligible for Medicaid again the following month. The first thing to do is pay the nursing home for the current month (at the Medicaid rate).

Minimizing the Amount of Your Inheritance

If you have money left after paying the nursing home, your elder law attorney can advise you on the proper way to spend down the money. You may be able to give it to a spouse, a child with special needs, or the child’s special needs trust. You may also pre-pay an irrevocable funeral contract or buy burial items for a close relative. It could also be spent on travel, dining out, clothes, television, DVD player, and paying off any debts you may have. In most cases, you can’t make gifts with the money, but there are some exceptions to this rule, and in some states, good planning techniques may permit some gifting. To be sure, you will need to consult with your elder law attorney.

If the inheritance is too large to spend in one month, your attorney may be able to use other Medicaid planning techniques to protect a portion of it.

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