How to Plan for Independent Contractor Taxes
Independent contractors can be people or entities who are contracted to perform work for another entity in a non-employee relationship.
Over the years, a growing gap between the middle class and the upper class has led to a bevy of new tax laws and rules that are designed to level the playing field, so to speak. And regardless of which side of the political fence you land on, you’re required to play by the rules.
If you’re someone who has received – or is preparing to receive – a large inheritance from a loved one, it’s especially important that you understand how this money is taxed and what you can do to lower the amount that goes to the IRS.
What is an Inheritance Tax?
In the simplest terms, an inheritance tax is a state tax that’s imposed on the receipt of assets from someone who passes away.
While this might initially seem fairly straightforward, the details of how much inheritance tax is owed and when can quickly get sticky and convoluted. In particular, people get confused about the difference between estate taxes and inheritance taxes.
Contrary to popular belief, estate tax and inheritance tax are not one and the same. They’re two very distinct taxes – one paid by the deceased’s estate and the other paid by the beneficiaries. And depending on where someone dies, when they die, how much money they have upon death, how much wealth they’re transferring, and who they’re transferring it to, one, both, or neither of these taxes could be a factor.
Still not clear? Let’s dig in and learn a bit more.
Understanding the Estate Tax
Let’s start by clearing up any confusion on estate taxes. An estate tax is basically a tax on someone’s right to transfer property upon death. For 99 percent of people, the estate tax never comes into play. The IRS currently exempts estates of less than $11.4 million in 2019 and $11.58 million in 2020. Furthermore, the exemption is per person. This means married couples can double the amount.
For estates that exceed these thresholds, IRS tax rates apply up to 40 percent. And in most cases, the IRS taxes the assets at their current fair market value – not the amount the owner originally paid for them.
In addition to federal estate tax, certain states also charge an additional tax. In these cases, exemption thresholds can be much lower. Massachusetts, for example, enforces a state-level estate tax on estates worth $1 million or more.
Understanding the Inheritance Tax
Inheritance tax refers to taxes that recipients are required to pay in the year that they receive the assets. While there is no federal inheritance tax, there are state-level taxes in Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania.
While you’ll need to do some thorough reading and/or speak with a tax professional to understand the rules in your state, here’s a broad overview of some of the rules in each of the six states that levy an inheritance tax:
Iowa. There’s no inheritance tax on estates less than $25,000, or on estates that are left to a spouse, child, parent, grandparent, grandchild, or other lineal relative. Siblings pay between 5 percent to 10 percent. Aunts, uncles, nieces, nephews and other individuals pay between 10 percent to 15 percent. The tax rate on corporations and for-profit organizations is 15 percent, while charitable and religious organizations pay 0 to 10 percent.
Kentucky. There is no inheritance tax on surviving spouses, children, grandchildren, parents, or siblings. Other relatives pay between 4 percent and 16 percent, depending on the size of the estate. The tax rate scales between 6 percent and 16 percent for all other beneficiaries (including organizations and charities).
Maryland. Lineal descendants pay no tax. Domestic partners who inherit a joint primary residence are exempt from inheritance tax on the residence. All other individuals pay a flat 10 percent tax.
Nebraska. There are varying levels of exemptions based on the relationship of the heir to the deceased person. The tax rate also varies based on relationship. Nonrelatives can pay as much as 18 percent on amounts above $10,000.
New Jersey. Lineal descendants don’t pay any inheritance tax. Siblings, civil-union partners, sons-in-law, and daughters-in-law pay no tax on the first $25,000 of inheritance. For amounts above this threshold, tax rates scale between 11 percent to 16 percent. Qualifying charities, religious institutions, and non-profit organizations pay no taxes.
Pennsylvania. Tax rates vary based on age and relationship. Adult lineal heirs pay just 4.5 percent, for example, while siblings pay as much as 12 percent. There are also certain exemptions in place for farmland and agricultural property.
If you don’t live in one of these states, you most likely won’t have to pay any sort of inheritance tax. However, estate taxes could reduce the amount you receive if the deceased relative’s estate is required to pay federal estate taxes, state taxes, or a combination of the two.
Reducing and Avoiding Inheritance Tax
If you live in one of the six states that levies an inheritance tax, you should be thinking about ways to strategically reduce the amount the individuals in your inheritance will owe. Here are some legal strategies and maneuvers you can use:
Ensure There’s a Will
Dying without a will is a mistake. If you want to protect your nest egg and lower the tax burden on the individuals within your inheritance, a will can help you strategically manage the flow of assets in a way that limits taxes on everyone.
2. Give Assets Away Prior to Death
One of the great things about the tax code is that you’re able to gift money to your loved ones while you’re still living without triggering any federal taxes for you or the recipient.
Currently, you’re able to gift up to $15,000 per recipient per year without triggering federal gift taxes. And if you’re married, both you and your spouse can each gift $15,000 per person per year. This means if you have a son who is married, you can gift up to $30,000 to him and up to $30,000 to his wife per year without any tax consequences.
There are also other gifting strategies you can use. If you have a large estate, consider meeting with an estate-planning attorney to determine which lawful options you have to reduce taxes owed after death.
3. Utilize a Trust
A trust is a fiduciary arrangement that allows you to legally shield money from certain taxes, like inheritance tax. While an estate-planning attorney can walk you through the details, you typically name trustees and are able to regularly or periodically fund the account throughout your life. You can even place assets like real estate into a trust.
4. Take Out Life Insurance
If you’re worried that a large portion of your nest egg could be exposed to an estate tax or inheritance tax, you can always take out a life insurance policy to help cover these costs. The insurance policy can be placed in a trust to ensure it’s properly utilized.
Find a Qualified CPA With Taxfyle
As you can see, there are plenty of complexities associated with estate taxes and inheritance taxes. Trying to figure out how all of this works on your own is a recipe for disaster. Thankfully, Taxfyle has the ability to put you in touch with a qualified and experienced CPA who can provide advice and recommendations that are specific to your situation. Click here to learn more!
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