Inheritance Tax

Inheritance Tax (IHT) is the tax' your estate' pays when you die although it can also be charged on certain lifetime gifts. However, Inheritance tax is not just a concern for the seriously wealthy. It is a growing worry for many people - but unlike many other taxes, there are plenty of things you can do now to make sure you pass as much of your wealth on to your family and friends, not the taxman.

So unless you plan carefully then it is possible that your estate too will be hit by Inheritance tax. It may seem very unfair that even after death, we are still pursued by the taxman. But plan now and you could cut the amount of inheritance tax your estate has to pay - meaning there will be more to pass on to your family and friends.

Inheritance tax is sometimes called a 'voluntary tax' by accountants simply because there is so much you can do to reduce its effect. After all, as American author and statesman Benjamin Franklin is reported to have said 'In this world nothing can be said to be certain, except death and taxes.' You can't do anything about the first, but prudent planning can reduce the pain of the second.

Are gifts, bequests, or inheritances taxable?

Generally, property you receive as a gift, bequest, or inheritance is not included in your income. However, if property you receive this way later produces income such as interest, dividends, or rentals, that income is taxable to you. For additional information, refer to Publication 17, Your Federal Income Tax, Chapter 13. If you inherit an Individual Retirement Arrangement (IRA) or proceeds from a retirement (pension) plan, special rules apply. Refer to Publication 590, Individual Retirement Arrangements (IRAs), or Publication 575, Pension and Annuity Income, for further information.

What is the basis of property received as a gift?

To figure the basis of property you get as a gift, you must know its adjusted basis to the donor just before it was given to you. You also must know its fair market value (FMV) at the time it was given to you. If the FMV of the property at the time of the gift is less than the donor's adjusted basis, your basis depends on whether you have a gain or loss when you dispose of the property. Your basis for figuring gain is the same as the donor's adjusted basis, plus or minus any required adjustments to basis while you held the property. Your basis for figuring a loss is the FMV of the property when you received the gift, plus or minus any required adjustments to basis while you held the property. See Adjusted Basis in Publication 551, Basis of Assets.

If you use the donor's adjusted basis for figuring a gain and get a loss, and then use the FMV for figuring a loss and get a gain, you have neither a gain or loss on the sale or disposition of the property.

If the FMV is equal to or greater than the donor's adjusted basis, your basis is the donor's adjusted basis at the time you received the gift. Increase your basis by all or part of any gift tax paid, depending on the date of the gift. Also, for figuring gain or loss, you must increase or decrease your basis by any required adjustments to basis while you held the property. See Adjusted Basis in Publication 551, Basis of Assets.

If you received a gift before 1977, increase your basis in the gift (the donor's adjusted basis) by any gift tax paid on it. However, do not increase your basis above the FMV of the gift at the time it was given to you.

If you received a gift after 1976, increase your basis by the part of the gift tax paid on it that is due to the net increase in value of the gift. Figure the increase to basis by multiplying the gift tax paid by the following fraction. The numerator of the fraction is the net increase in value of the gift and the denominator is the amount of the gift.

The net increase in value of the gift is the FMV of the gift less the donor's adjusted basis. The amount of the gift is its value for gift tax purposes, after reduction by any annual exclusion and any marital or charitable deduction that applies to the gift. For more information on the gift tax, please see Publication 950, Introduction to Estate and Gift taxes.

I received stock as a gift from my grandparents. I am selling the stock this year. How can I figure the basis of the gifted stock?

To figure the basis of property you receive as a gift, you must know its adjusted basis to the donor just before it was given to you, its fair market value (FMV) at the time it was given to you, and the amount of any gift tax paid on it.

If the FMV of the property was less than the donor's adjusted basis, your basis for figuring gain on its sale or other disposition is the same as the donor's adjusted basis plus or minus any required adjustment to basis during the period you held the property. Your basis for figuring loss on its sale or other disposition is its FMV at the time you received the gift plus or minus any required adjustment to basis during the period you held the property.

If the FMV of the property was equal to or greater than the donor's adjusted basis, your basis for figuring gain or loss on its sale or other disposition is the same as the donor's adjusted basis at the time you received the gift. Increase your basis by all or part of any gift tax paid, depending on the date of the gift.

Are business gifts deductible?

If you give business gifts in the course of your trade or business, you can deduct the cost subject to special limits and rules. In general, you can deduct no more than $25 for business gifts you give directly or indirectly to any one person during your tax year.

Is the money received from the sale of inherited property considered taxable income?

To determine if the sale of inherited property is taxable, you must first determine your basis in the property. The basis of inherited property is generally one of the following:

(1) The fair market value (FMV) of the property on the date of the decedent's death.

(2) The FMV of the property on the alternate valuation date if the executor of the estate chooses to use alternate valuation. See Form 706 (PDF), United States Estate (and Generation-Skipping Transfer) Tax Return.

(3) The special use valuation for estate tax purposes of qualified real property used for farming purposes or in a trade or business other than farming. However, if an interest in such property is disposed of or ceases to be used in a qualified use during the 10 year period following the decedent's death, additional estate tax is imposed. If the qualified heir elects to pay interest on the additional estate tax, the adjusted basis of the property will be deemed to have been increased, immediately before disposition, by an amount equal to the excess of its fair market value on the date of the decedent's death over its special use value. See Form 706 (PDF), U.S. Estate (and Generation-Skipping Transfer) Tax Return and section 2032A of Internal Revenue Code.

(4) If an election is made to exclude a portion of the value of land from a decedent's gross estate section 2031 (c) (regarding the transfer of qualified conservation easement), the decedent's adjusted basis in the land to the extent the value of the land was excluded from the decedent's gross estate under 2031(c) by reason of the transfer of a qualified conservation easement plus the fair market value of the land to the extent the value of the land was included in the gross estate. For more information on qualified conservation easement see the Instructions for Form 706, U. S. Estate (and Generation-Skipping Transfer) Tax Returnand section 2031(c) of the Internal Revenue Code.

If you or your spouse gave the property to the descendent within one year of their death, see Publication 551, Basis of Assets.

Report the sale on Form 1040, Schedule D (PDF), Capital Gain and Losses. If you sell the property for more than your basis, you have a taxable gain. For information on how to report the sale on Schedule D, please see Publication 550, Investment Income and Expenses.

Are proceeds paid under a life insurance contract as defined in IRC 7702 taxable and do they have to be reported as income?

Generally, if you receive the proceeds under a life insurance contract because of the death of the insured person the benefits are not taxable income and do not have to be reported. Any interest you receive would be taxable and would need to be reported just like any other interest received.

However, if the policy was transferred to you for valuable consideration, the amount excluded from gross income, pursuant to IRC 101 (a) (1), shall not exceed an amount equal to the sum of the value of the consideration you paid for the transfer of the policy and other amounts you subsequently paid by the transferee.

How do I determine how much interest to report on U.S. savings bonds I inherited?

You may have choices, but it will depend on several factors. Before your question can be answered, you'll need to know:

* the date of death of the deceased,
* the type of bond you inherited (Series EE, Series E, Series I, or Series HH, or Series H),
* whether the deceased was reporting the interest yearly or not, and
* whether any of the interest was included on the decedent's final income tax return.

Once you have these facts, you can find your answer and any options that may be available by reading the appropriate section of Publication 550, Investment Income, Chapter 1, or call 800-829-1040.

Is deferred interest on a U.S. savings bond (series EE, E, or I) that I inherited taxable to the deceased owner's estate, to the deceased on his or her final tax return, or to me when I cash them?

The deferred interest is not taxable to the estate. It is going to either be reported on the final return of the decedent or be reported by you, depending on the choice you make. If you are the surviving spouse, the choice is made by the executor or administrator of the decedent's estate as to who is responsible for filing the decedent's final return.

You may have choices, but it will depend on several factors. Before your question can be answered, you'll need to know:

* the date of death of the deceased,
* the type of bond you inherited (Series EE, Series E, Series I, or Series HH, or Series H),
* whether the deceased was reporting the interest yearly or not, and
* whether any of the interest was included on the decedent's final income tax return.

Once you have these facts, you can find your answer and any options that may be available by reading the appropriate section of Publication 550, Investment Income, Chapter 1, or call 1-800-829-1040.

Can interest from some inherited U.S. savings bonds be included on the decedent's final income tax return and interest from other inherited U.S. savings bonds be included as interest to the beneficiary?

The same method of reporting interest must be used for all saving bonds owned by an individual. If the surviving spouse or executor of the decedent's estate elected to report accrual interest on bonds owned by the decedent and the decedent had not reported interest on saving bonds prior to their disposition or maturity, the surviving spouse executor of the decedent's estate would be required to treat all savings bonds owned by the decedent the same way. If you receive Series EE or Series I bonds from an estate in satisfaction of a specific dollar amount legacy and the decedent was a cash method taxpayer who did not elect to report interest each year, the interest earned after you receive the bonds is your income. The income earned to the date of death plus any further interest earned to the date of distribution of the bonds to you is income to (and reportable by) the estate. You have a choice. You can report the interest on the series EE or series I bonds, which you received in satisfaction of specific legacy, each year or you can report the interest which accrues from the date the bonds were distributed to you until the date you cash the bonds as interest in the taxable year in which you cash the bonds. If you have other series EE or series I bonds, you will be required to treat the interest on the saving bonds received in satisfaction of the specific legacy in the same way that you treat interest on the other savings bonds.

Inheritance Tax