19 Jun I inherited my friend’s estate. Can we talk taxes?

Q. I am a New Jersey Class D beneficiary for my friend’s entire estate. I am the named beneficiary on her IRA which will require payment of a 15% inheritance tax. All inheritance taxes are to be paid from the residual estate, which is mine also, in accordance with the will. Is there a federal or New Jersey tax deduction for the remainder of my friend’s Required Minimum Distribution (RMD) that I must take this year as income? And as I take RMDs over the next 10 years, is there a federal or New Jersey deduction or reduction for the inheritance tax paid? Seems like a lot of tax to pay inheritance taxes and then income taxes.
— Beneficiary

A. We’re sorry to hear about your friend.

And indeed, the inheritance tax can feel weighty.

You are correct that Class D beneficiaries — those who are not a spouse, grandparent, parent or descendant or stepchild of the deceased, nor a sibling nor in-law — will pay a 15% inheritance tax on assets received equal to or greater than $500 but below $700,000, said Catherine Romania, an estate planning attorney with Witman Stadtmauer in Florham Park.

Above that sum, the tax is 16%, she said.

The tax is in addition to a federal estate tax that would be paid if the entire estate together with lifetime gifts exceed the exemption amount, which is $13,61 million, she said.

“If the decedent did not take distribution of his or her full required minimum distribution (RMD) in the year of death, then the remainder of the RMD should be paid before Dec. 31 of the year of death and is paid to the designated beneficiary of the IRA,” Romania said. “The beneficiary includes that RMD in his/her taxable income for the year of distribution.”

The full value of the IRA as of the date of death, including the undistributed amount of the decedent’s RMD, is included in the decedent’s estate for estate and inheritance tax purposes, she said.

Therefore, estate and inheritance tax paid are in addition to income tax paid, Romania said.

“Assets such as annuities and retirement accounts do not get a step-up in basis upon death so that any income/appreciation in such assets above the decedent’s basis will be taxed to the beneficiary when the assets are liquidated,” she said. “Moreover, it is taxed as ordinary income — not capital gain.”

If, however, you paid federal estate tax, you are entitled to a deduction on your income tax return as permitted by Section 691(c) of the Internal Revenue Code relative to the estate tax paid, she said.

“Similarly in computing your income tax for New Jersey, when inheritance taxes are paid on an IRA, only the increase in value since the date of death should be taxed by the State of New Jersey,” she said. “In other words, the value reported and taxed on the inheritance tax return is deemed the beneficiary’s basis for New Jersey income tax purposes.”

Thus, the estate or inheritance tax on such retirement assets may reduce the income tax payable on such assets, she said.

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This story was originally published in June 2024.

NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.