I'd like to start off with a MAJOR caveat. The taxes I will be discussing in this post relate to taxes associated with the act of death, and taxes associated with the estate or estate assets. The taxation of qualified retirement accounts (IRAs, 401Ks, etc.) is a whole different discussion. But for purposes of our discussion, it should be noted that those taxes are income taxes that should have been paid while the individual was still alive, but are now paid solely because the individual has died....so these taxes are income taxes of the decedent, and although they could (and should) be planned for to minimize or defer, they should not be confused with the more common taxes associated with death, estates, estate assets, and inheritances as discussed below:
THE INHERITANCE TAX: The inheritance tax is not really a tax. Technically it would be a tax on the amount of assets transferred to an individual (as opposed to the Estate Tax, which would be a tax on the estate before it is distributed). I am not a history buff, but I believe this tax may have existed in the past, and may even exist in a couple states (on the state level only), but it is mostly a rumor driven by fear. Simply put, there is no such thing (in California) as an “Inheritance Tax” levied against assets for the sole reason that you inherited them. Non-issue.
INCOME TAXES ON THE INHERITANCE AGAINST THE BENEFICIARIES: Let’s look a little longer at the beneficiary. If one inherits $100,000, is that income? Is that taxed just like wages, salaries, and other earnings? The short answer? No. And there really is no long answer. It is not income, and it does not even need to be reported. Non-issue.
As you can see, so far, these seemingly major taxes are really moot points for most of us. Let's look at one more set of taxes, that does apply to quite a few.
TAXES ASSOCIATED WITH REAL ESTATE: There is typically a Capital Gain Tax on capital property (real estate) on any growth or gain on that property. If a house is in a trust (or passes through probate), the "cost basis" (think purchase price) is reset for the beneficiary, so when the beneficiary sells the property, his or her gain is calculated from the date-of-death value of the property rather than from the original purchase price. Note that this "benefit" does not fully apply to jointly owned property...even with spouses. As so, it is always best to hold real estate in a trust for purposes relating to this tax. Also, there are the property taxes which are levied against the assessed value, which is typically the original purchase price of the property. This is a value that we always want to keep low, and can be "frozen" so long as the the property is left from parent to child (or grandchild if child is deceased). Careful consideration should be given to one's plan so as to preserve this linear distribution resulting in minimal property taxes. Note that this is not automatic, and must be declared separately. Lastly, the Documentary Transfer Tax is applied to the transfer of property...similar to a sales tax. Given the fact that the types of transfers of property discussed are for no consideration (no money changes hands), the Documentary Transfer Tax does not apply. In sum, although there are a few taxes associated with Real Estate, they can be managed with proper planning and advice.
In conclusion, taxes associated with death will not be a huge problem for most of us, but they should be looked at nevertheless, to ensure minimal or no exposure at all.
A brief recap:
The Estate Tax: Not a problem for estates less than $5M / $10M
The Inheritance Tax: Does not exist.
Income Tax of Beneficiary: Inherited money is not considered income, and is not taxed.
Taxes Associated with Real Estate: A real thing, but can be easily managed with property legal advice and counsel.