Inheriting assets can be a bittersweet experience. While it often signifies the passing of a loved one, it can also provide financial stability and opportunities for the future. However, along with the emotional and financial aspects of inheritance come tax implications, especially regarding inherited accounts. Understanding how taxes apply to inherited accounts is crucial for effective estate planning and financial management. In this article, we’ll explore the complexities of taxes on inherited accounts and explore strategies to navigate them.
SECURE Act
It’s important to know that taxes on inherited accounts is an extremely complex topic. This topic was made even more confusing by the 2019 SECURE Act and 2022’s SECURE Act 2.0. To put it simply, the SECURE Act focuses on a few key areas to improve retirement plans.
Expanded Access: Requires employers to allow long-term part-time employees who work at least 500 hours per year for three consecutive years to participate in their employer’s 401(k) plan.
Increased RMD Age: The age at which individuals must start taking required minimum distributions (RMDs) from their retirement accounts was raised from 70½ to 72. It was raised to 73 in 2023. This change allows individuals to keep their retirement funds invested for a longer period, potentially increasing their savings.
Birth or Adoption Expenses: Allows penalty-free withdrawals of up to $5,000 from retirement accounts for expenses related to the birth or adoption of a child. While the withdrawal is penalty-free, income tax still applies to the distribution.
Elimination of “Stretch” IRAs: Eliminates the “stretch” IRA provision for most non-spouse beneficiaries. Previously, non-spouse beneficiaries could stretch distributions from inherited IRAs over their lifetimes, allowing for potentially significant tax-deferred growth. Now, most non-spouse beneficiaries are required to withdraw the entire inherited IRA balance within 10 years of the original account holder’s death, potentially accelerating tax liabilities.
Knowing these provisions is key to understanding taxes on inherited accounts. The way a surviving spouse is taxed is different from the way a child or relative is taxed. Similarly, non-relatives are taxed differently. Knowing what your options are if you inherit an account can save you time, money, and a headache.
Types of Inherited Accounts
Keeping the SECURE Act in mind, we can now look at the different types of inherited accounts. Inherited accounts come in various forms, including retirement accounts like Individual Retirement Accounts (IRAs), employer-sponsored retirement plans such as 401(k)s, taxable investment accounts, and other financial assets. Each type of account may have different tax implications for beneficiaries. In most scenarios, you may inherit IRAs, employee-sponsored retirement plans, and investment accounts.
Traditional and Roth IRAs
Perhaps the most important factor that determines options when inheriting accounts is your relationship to the deceased. When inheriting a traditional IRA, beneficiaries typically must pay income tax on distributions they receive. The tax is based on the beneficiary’s individual tax rate. However, if the deceased had already begun taking required minimum distributions (RMDs), the beneficiary may need to continue taking them based on their life expectancy.
In contrast, inheriting a Roth IRA usually offers tax advantages. Qualified distributions from a Roth IRA are tax-free, so beneficiaries can potentially enjoy tax-free growth on inherited assets. However, non-qualified distributions may be subject to taxes and penalties. For example, if the Roth account is less than 5 years old at the time of withdrawal, the withdrawal may be subject to income tax.
Non-Spouse Beneficiaries
If you inherited an account from a parent, relative, or anything other than a spouse, your options are more limited. For example, you cannot roll inherited IRA funds into an IRA in your name. Also, if you plan to take RMDs using the life expectancy method, you must meet one of the following requirements:
You inherited the funds from someone who died in 2019 or earlier
You are chronically ill or disabled
You are more than 10 years younger than the deceased account owner
You are a minor child of the deceased account owner. If this is the case, you must use the life expectancy method until you reach age 18.
If you don’t meet any of these criteria, you can spread the withdrawals over a 10-year period. Alternatively, you can withdraw over 5 years or take a lump sum withdrawal.
Employer-Sponsored Retirement Plans
Similar to traditional IRAs, beneficiaries of employer-sponsored retirement plans like 401(k)s may need to pay income tax on distributions they receive. You could take a lump sum distribution, but it will be taxed as ordinary income. You could also roll the funds into your own 401(k) or IRA. If you do this, you’ll follow the same withdrawal rules. For instance, you be penalized for early withdrawals, and you must start taking RMDs by age 73. If you choose to transfer the funds into an inherited IRA account, you can make early withdrawals. On the other hand, you don’t need to move the funds at all. You can leave it in the account and take RMDs when required. However, if you are over 59½ and your spouse began taking RMDs before they passed, you can continue those withdrawals or delay it until you reach age 73 without any penalty.
Non-Spouse Beneficiaries
Once again, non-spouse beneficiaries have less options than spouses. You have three options for this type of account.
Transfer funds into an inherited IRA: This option requires the funds to be completely withdrawn within 10 years. If the money was pre-tax, you’ll pay tax on the withdrawals. If you convert a pre-tax 401(k) into a Roth IRA, you’ll likely owe taxes at the time of conversion. Withdrawing from a Roth 401(k) or converting the account to a Roth IRA has no tax implications.
Take a lump sum payment: This option generally results in a large tax bill. If you inherit a pre-tax 401(k), you’ll pay at your ordinary tax rate. If it’s a Roth 401(k), there are no tax implications.
Leave the funds and withdraw over 10 years: You can leave the funds in the original account, but you still need to meet the 401(k) 10-year rule.
Inherited Stock
Inheriting taxable investment accounts generally involves capital gains taxes. When beneficiaries sell inherited assets, they may incur capital gains tax based on the difference between the asset’s value at the time of inheritance and its value at the time of sale. However, inheriting assets also offers a “step-up” in basis, which can reduce capital gains taxes by resetting the cost basis to the asset’s value at the time of the original owner’s death.
Here’s an example. Let’s assume you sell inherited stocks one year after inheriting them. The stocks were worth $100,000 when you inherited them, and you sold them for $120,000.
Capital Gain = Sale Price – Fair Market Value at Inheritance
Capital Gain = $120,000 – $100,000 = $20,000
If your capital gains rate is 15%, you’d owe $3,000 in capital gains tax.
Capital Gains Tax = Capital Gain × Capital Gains Tax Rate
Capital Gains Tax = $20,000 × 0.15 = $3,000
Tax Help for Those Who Inherited Accounts
Inheriting accounts comes with both financial opportunities and tax obligations. Understanding the tax implications of inherited assets is crucial for maximizing their value and minimizing tax liabilities. By implementing strategic tax planning strategies and seeking professional guidance, beneficiaries can navigate the complexities of taxes on inherited accounts effectively. Optima Tax Relief has a team of dedicated and experienced tax professionals with proven track records of success.
In an era where remote work is becoming increasingly prevalent, individuals are enjoying the freedom and flexibility that come with working from the comfort of their own homes. However, along with this newfound flexibility comes the responsibility of managing your finances efficiently, especially when it comes to taxes. Remote workers face unique tax considerations that differ from traditional office employees. Here are some essential tax tips to help remote workers navigate the complexities of the tax system and maximize their financial well-being.
Understand Your Tax Residency
Tax residency is crucial for remote workers, especially if you live in one state but work remotely for a company located in another state or even country. Your tax obligations can vary depending on where you are considered a resident for tax purposes. Be sure to understand the residency rules of both your home state and the state or country where your employer is based.
Be Aware of State Tax Implications
As a remote worker, you may need to file taxes in multiple states, depending on where you live and where your employer is located. Some states have reciprocal agreements that allow residents to avoid double taxation, while others require you to file state taxes in both your home state and the state where your employer is based. Familiarize yourself with the tax laws of each state to ensure compliance and minimize your tax burden.
Keep Detailed Records
Remote workers often have various work-related expenses, such as home office costs, internet bills, and equipment purchases. Keeping detailed records of these expenses throughout the year can help maximize your deductions come tax time. Utilize tools like expense tracking apps or spreadsheets to keep everything organized.
Claim Home Office Deductions
If you use a dedicated space in your home for work, you may be eligible to claim a home office deduction. The IRS offers two methods for calculating this deduction: the simplified method, which allows you to deduct $5 per square foot of your home office space, up to 300 square feet, or the regular method, which involves calculating the actual expenses associated with your home office, such as rent, utilities, and home maintenance costs. However, you should confirm your eligibility for this deduction before claiming it. W-2 employees are not eligible for this deduction. This deduction is for self-employed individuals.
Take Advantage of Retirement Accounts
Remote workers often have more flexibility when it comes to retirement planning. Consider contributing to tax-advantaged retirement accounts such as a traditional or Roth IRA, SEP IRA, or Solo 401(k). These accounts offer various tax benefits, including tax-deferred or tax-free growth, depending on the type of account you choose.
Plan for Estimated Taxes
Unlike traditional employees who have taxes withheld from their paychecks, some remote workers are typically responsible for paying estimated taxes quarterly. Failure to pay estimated taxes on time can result in penalties and interest charges. Keep track of your income throughout the year and make quarterly estimated tax payments to avoid any surprises at tax time.
Seek Professional Guidance
Tax laws can be complex and subject to change, especially for remote workers with unique circumstances. Consider consulting with a tax professional who specializes in remote work to ensure you’re taking full advantage of all available deductions and credits while staying compliant with tax laws.
Tax Help for Remote Workers
By understanding these essential tax tips and implementing sound financial practices, remote workers can effectively manage their tax obligations and maximize their financial well-being. With proper planning and diligence, you can make the most of your remote work lifestyle while minimizing the stress of tax season. Optima Tax Relief is the nation’s leading tax resolution firm with over a decade of experience helping taxpayers with tough tax situations.
Today, Phil discusses what options you have if you cannot afford to do your taxes.
If you can’t afford to do your taxes, you can check to see if you’re eligible for free tax preparation. You can check out these two sites for more information.
If you would like to file your own taxes for free, you also have options. One of these is through IRS Free File. The program is a partnership between the IRS and various tax preparation software companies that provide free online tax preparation and filing services to eligible taxpayers based on their income level. IRS Free File offers a variety of tax preparation options, including both guided and self-preparation tools, to accommodate different levels of tax filing complexity. Taxpayers can choose the software that best fits their needs and preferences.
IRS Direct File
The IRS just launched a new program, Direct File, which allows residents of 12 pilot states to file their federal taxes online directly with the IRS for free. The pilot states included are Arizona, California, Florida, Massachusetts, Nevada, New Hampshire, New York, South Dakota, Tennessee, Texas, Washington and Wyoming. Taxpayers should also be aware of other limitations surrounding wages, deductions, and credits.
Be sure to take advantage of one of the many free tax-filing services the IRS offers. Tune in next Friday when Phil talks about his three takeaways from the current tax landscape.
Tax deductions can help lower your tax bill and even increase your tax refund on your return. While most people are aware of common deductions like mortgage interest, charitable donations, and medical expenses, there are a plethora of lesser-known expenses that could potentially save you money on your taxes. There are several tax deductions you might not know are deductible.
Sales Taxes
For taxpayers who itemize deductions, you can deduct either state and local income taxes or state and local sales taxes paid throughout the year. In some tax years and states, it might make sense to itemize your deductions rather than take the standard deduction. This deduction can be particularly advantageous for residents of states with no income tax or for those who made significant purchases subject to sales tax. For example, if you made a large purchase like a vehicle or engagement ring, you could deduct sales taxes off your federal return. Or, if you live in a state that does not impose a state income tax, you could write off the sales tax you paid that year.
Medical Expenses
You can deduct medical expenses that exceed 7.5% of your AGI if you itemize your deductions. On the other hand, if you’re self-employed, you may be able to deduct 100% of your health insurance premiums. To qualify, you must have no other health insurance coverage. You may only deduct the amount of business income earned that year.
Home Office Deduction
Any space in your home used exclusively for conducting business can be deducted at $5 per square foot, up to 300 square feet. This home office deduction is meant for self-employed individuals. In other words, if you are a W-2 employee who works remotely, you do not qualify.
Charitable Contributions
Cash donations to approved charities can be deducted for up to 50% of your AGI. However, you must be substantiated with bank statements or receipts. Non-cash donations can be deducted at fair market value. Even out-of-pocket expenses for charitable work can be deducted. For example, you can deduct the cost of gasoline to travel to complete charitable work. Alternatively, you can deduct mileage. The standard mileage rate for charitable travel in 2023 was 14 cents per mile and it will remain at this rate in 2024.
Be sure to confirm that the charity has a tax-exempt status with the IRS before donating if you plan to claim a deduction. A few examples of approved organizations include a trust, foundation, church, synagogue, or other religious organizations, and veterans’ organizations.
Child & Dependent Care
If you pay a babysitter to watch your children while you work, look for work or attend school full-time, you may be able to claim the Child and Dependent Care Credit. This can also apply to care for an elderly parent. They must live with you and qualify as a dependent.
Student Loan Interest
If you are required to repay student loan debt, you can deduct the interest paid, up to $2,500. If your parents paid your student loan debt, the IRS views that money as a gift to you used to pay the loan. In this case, you can deduct up to $2,500 of the student loan interest they paid. That is as long as they do not claim you as a dependent on their tax return.
College Expenses
While most people are familiar with the deduction for tuition and fees, other educational expenses may also be deductible. This includes costs for workshops, seminars, and even certain textbooks and supplies. In addition, some states even allow you to deduct contributions made to your 529 College Savings Plan.
State Tax Deductions
Your state may also offer its own set of unusual tax breaks. For example, Hawaii offers a tax deduction to taxpayers who maintain an “Exceptional Tree,” like the native Norfolk Pine. This deduction is up to $3,000 per tree and can be claimed once every three years. Alaska offers a deduction of up to $10,000 to offset the cost of whaling, which involves hunting whales to give the blubber and skin back to the community. New Mexico allows its residents to stop paying state income taxes once they reach 100 years old, as long as they’ve been a resident for the last six months.
Tax Relief for Taxpayers
Every tax situation is different. There are countless deductions and credits taxpayers can claim on their federal or state returns. Overall, the best thing to do is speak with a tax preparer about which deductions and credits you are eligible for and what substantiation might be needed to claim them. However, do remember claiming deductions without proper substantiation can lead to audits and delays in processing your return.
Tax season can often be a stressful time for many individuals and families, especially those with limited financial resources or complex tax situations. Fortunately, there exists a vital resource that provides much-needed assistance to these individuals: the Volunteer Income Tax Assistance (VITA) program. Developed by the IRS, the VITA program offers free tax help to those who need it most, ensuring that everyone has access to accurate tax preparation services regardless of their income level.
What is the VITA Program?
The Volunteer Income Tax Assistance (VITA) program is a federal initiative that provides free tax preparation and filing assistance to low-to-moderate-income individuals, persons with disabilities, non-English speakers, and the elderly. It operates through a network of community-based organizations, nonprofits, and local government agencies, staffed by trained volunteers who assist taxpayers in completing their tax returns accurately and efficiently.
Key Features and Benefits
There are several reasons why taxpayers should take advantage of the VITA program if they qualify for it.
Free Tax Preparation Services
One of the biggest advantages of the VITA program is its ability to provide free tax preparation services. For individuals and families living paycheck to paycheck, the cost of professional tax assistance can be prohibitive. VITA removes this barrier by offering its services at no cost.
Trained Volunteer Assistance
Volunteers in the VITA program undergo training provided by the IRS. These volunteers are equipped with the knowledge and skills necessary to assist taxpayers with various tax situations, including claiming credits and deductions they may be eligible for, such as the Earned Income Tax Credit (EITC) and the Child Tax Credit.
Accessibility and Inclusivity
The VITA program aims to reach underserved communities and populations that may face barriers to accessing traditional tax preparation services. This includes non-English speakers, individuals with disabilities, and elderly taxpayers. VITA sites often offer multilingual assistance and accommodations for persons with disabilities, ensuring that everyone can receive the help they need.
Electronic Filing and Faster Refunds
VITA sites typically offer electronic filing options, allowing taxpayers to submit their returns quickly and securely. This not only expedites the processing of tax returns but also enables taxpayers to receive any refunds owed to them in a timely manner, providing much-needed financial relief.
Quality and Accuracy
Despite being a volunteer-driven program, VITA maintains high standards of quality and accuracy in tax preparation. Volunteers are trained to adhere to IRS guidelines and regulations, minimizing the risk of errors and ensuring that taxpayers’ returns are completed correctly.
Eligibility Requirements
Unfortunately, not everyone qualifies for the VITA program. The program is generally available to those who earn $64,000 or less, those with disabilities, or non-English speakers. It’s also important to note that the VITA program offers basic tax preparation. In other words, it will not work for you if your tax situation is complicated. Which VITA site you visit will also determine the level of expertise you receive since volunteers may not all have the same skillset. In any case, you can view the VITA locations on the IRS website.
Tax Help for the 2024 Tax Season
The Volunteer Income Tax Assistance (VITA) program plays a crucial role in providing free tax assistance to millions of individuals and families across the country. By offering accessible, accurate, and reliable tax preparation services, VITA helps alleviate financial burdens and promote economic stability within communities. If you find yourself in a more complicated tax situation, there are other ways to get help. Optima Tax Relief is the nation’s leading tax resolution firm with over a decade of experience helping taxpayers with tough tax situations.
