A key component of estate planning is minimizing and planning for the taxes that might be owed.
Each state has its own rules, so this post concentrates on Maryland. In Maryland, there are typically three potential taxes that might be owed when someone dies: estate tax, inheritance tax, and income tax.
Estate Taxes
Estate taxes are taxes imposed on your estate’s value when you pass away. For both Maryland and federal taxes – no tax is owed when the assets are inherited by the surviving spouse. The estate tax is calculated based on the total value of your assets at the time of death minus any debts, liabilities, and expenses. For the tax year 2023, estates valued at $12,920,000 or less are exempt from federal estate tax. Maryland’s exemption amount is $5,000,000.
If your estate is subject to estate tax, it is typically the responsibility of your estate to pay the tax. Your personal representative will need to file an estate tax return with the Comptroller of Maryland and possibly the IRS. Any taxes owed are typically paid from the decedent’s probate assets before they are distributed to the beneficiaries.
A well-prepared estate plan can minimize or possibly eliminate Federal and Maryland estate tax in many cases.
Inheritance Taxes
Inheritance taxes are state only taxes imposed on the value of the assets a beneficiary receives from an estate. Not all states have inheritance taxes, and the rules and exemptions vary from state to state. In Maryland, inheritance tax is only owed when the gift is given to someone other than a spouse, sibling, or lineal relative (child, grandchild, parent, or grandparent). The tax is typically owed by the beneficiary.
It is typically the responsibility of the beneficiary to pay any inheritance taxes owed. But the will can also allow the tax to be paid before the funds are distributed to the beneficiary.
Depending on the will or lack of will, inheritance taxes are either 10% or 11.11% of the value of the asset in question.
Income Tax
In addition to estate and inheritance taxes, there may be income tax implications for the estate and the beneficiaries. When assets are distributed from the estate to the beneficiaries, some income tax may be owed by the beneficiary on the asset received.
For example, if the estate includes a retirement account such as an IRA or 401(k), the beneficiaries may be required to pay income tax on the distributions they receive from the account. Similarly, if the estate includes rental properties or other investments that generate income, the beneficiaries may be subject to income tax on the earnings from those assets.
It’s important to work with a qualified estate planning attorney and tax professional to understand your estate plan’s tax implications and ensure that your assets are distributed in a way that minimizes taxes and maximizes the benefits to your beneficiaries. By taking the time to plan ahead and understand the tax rules, you can help ensure that your loved ones receive the maximum benefit from your estate.