During the creation or revision of your estate plan, it is crucial to consider the impact that various taxes will have on your plan. Most people are aware that their estate is subject to federal gift and estate taxes and that some states also impose a state gift and estate tax. One tax that is often overlooked when estate planning is the inheritance tax. Although New Hampshire does not collect an inheritance tax, the attorneys at Legacy Care Law Firm explain why it is important to understand how inheritance taxes could impact your New Hampshire estate plan.
What Is an Inheritance Tax?
An inheritance tax is a state-imposed tax on the assets that a beneficiary receives from a decedent’s estate. Inheritance taxes are different and distinct from federal or state gift and estate taxes. Whether imposed by the federal or state government, gift and estate taxes are levied on the total value of the decedent’s estate and are paid by the estate before assets are distributed. Inheritance taxes, on the other hand, are paid by the beneficiary after the assets are distributed and received by the beneficiary.
Inheritance taxes were first levied by the U.S. government back in 1862 to finance the Civil War. They were again collected by the federal government from 1898 to 1902 to help pay for the Spanish-American War. The U.S. federal government stopped collecting inheritances taxes in 1902. New York was the first state to impose an inheritance tax in 1885; however, by 1916 a staggering 43 states were collecting inheritance taxes. Today, only six states (Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania) impose an inheritance tax, and that number will be reduced to five on January 1, 2025, when Iowa’s inheritance tax ends. In the states that collect inheritance taxes, each state has its own rules regarding exemptions, tax rates, and which types of assets are subject to the tax. Typically, a beneficiary’s relationship to the decedent determines the tax rate with close relatives being subject to a lower rate than distant relatives and non-relatives.
How Inheritance Taxes Affect Beneficiaries
If one of your beneficiaries resides in a state with an inheritance tax, they may be required to pay a percentage of the inheritance they receive to the state, reducing the overall value of their inheritance. By way of illustration, imagine that you have two cousins with whom you share a very close relationship. One lives in New Hampshire and the other lives in Kentucky. You plan to leave $100,000 to each cousin in your estate plan. The cousin in New Hamsphire will receive the full $100,000 free and clear of any tax obligations. The cousin in Kentucky, however, is considered a “Class C” beneficiary and, as such, will be required to pay an inheritance tax of at least six percent and as high as 16 percent with only a $500 exemption (as of 2024). Consequently, the value of the inheritance your Kentucky cousin actually receives will be between $83,580 and $94,030. As you can see, your Kentucky cousin receives considerably less than your New Hampshire cousin after inheritance taxes are considered.
Another potential problem for your Kentucky cousin can crop up if the inheritance you pass down is in the form of non-liquid assets. For example, imagine that you passed down your vacation house, valued at $200,000 to your cousins (equally) instead of cash. Your New Hampshire cousin can simply start enjoying the use of the property. Your Kentucky cousin, however, must pay between $6,000 and $16,000 in inheritance taxes as a result of the inheritance – money that your cousin may not have.
How to Incorporate Inheritance Taxes into Your New Hampshire Estate Plan
Addressing inheritance taxes in your estate plan can help reduce the financial burden on your beneficiaries and ensure your assets are distributed as intended. To ensure that your estate plan works as intended, always work with an experienced estate planning attorney during the creation of the plan. In addition, consider the following tips:
- Understand the Tax Laws of the Beneficiary’s State: If you have beneficiaries living in states with inheritance taxes, familiarize yourself with the tax rates and exemptions in those states. If there is no way around paying the inheritance tax, make sure that you adjust the gifts made in your estate plan to account for the tax.
- Leverage Exemptions and Tax Breaks: Most states with inheritance taxes offer exemptions based on the relationship between the decedent and the beneficiary. For instance, surviving spouses are usually exempt from inheritance taxes in all six states that impose them. Children and other close relatives often benefit from lower rates or higher exemptions.
- Use Lifetime Gifting: One way to avoid inheritance taxes is by gifting assets to your beneficiaries during your lifetime. Federal tax laws allow you to gift up to a certain amount each year without incurring a federal gift tax. By transferring assets gradually, you can reduce the size of your taxable estate and potentially eliminate inheritance tax liability for your beneficiaries.
- Establish a Trust: A trust can be an effective tool for managing inheritance tax liability. Certain types of trusts, such as irrevocable trusts, allow you to transfer assets out of your estate, reducing the value of the estate subject to inheritance taxes. Trusts can also provide liquidity to pay taxes on non-liquid assets like property or businesses, ensuring those assets remain in the family.
- Consider Where Assets Are Located: If your estate includes property or investments in multiple states, the location of those assets may affect inheritance tax liability. An estate planning attorney can help you determine how the situs of your assets influences tax obligations and whether relocating certain assets is beneficial.
- Purchase Life Insurance: A life insurance policy can be used to offset inheritance tax liability. By naming a beneficiary directly on the policy, the proceeds can provide a source of funds to pay the tax without requiring the sale of other inherited assets.
Do You Have Additional Questions about Inheritance Taxes and Your New Hampshire Estate Plan?
For more information, please join us for an upcoming FREE seminar. If you have additional questions or concerns about how inheritance taxes might impact your New Hampshire estate plan, contact our estate planning attorneys in our North Andover, Woburn, and Beverly offices at (978) 969-0331. Our Salem and Nashua, New Hampshire office can be reached at (603) 894-4141.
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