If you live in Kentucky or are expecting an inheritance from someone who does, then it’s important to understand that state’s inheritance tax. Kentucky is one of only six U.S. states that currently imposes an inheritance tax on bequests, so it’s important to understand how the Kentucky inheritance tax works. Here are four things that you should know.
The Location of the Property is Critical
It’s vital to understand that the inheritance tax is not assessed against all property owned by a decedent and bequeathed to his heirs. It is only assessed on those properties located in the state of Kentucky and owned by the decedent. That’s a critical distinction that testators should remember when making out their estate plans, since it can help to determine who pays the inheritance tax and who does not.
For example, if you have property in and out of the state, you should carefully consider how you divide those assets. In most instances, you will want to give the out-of-state property to your more distant relatives, as long as those properties are in states without an inheritance tax. You can leave in-state assets to your closest heirs, since they are more likely to be exempt from any inheritance tax liability.
There are Three Beneficiary Classes
Kentucky has three distinct classes of beneficiary, and they each have their own exemptions. Those three classes include the following types of heirs, separated by their familial relationship to the deceased:
- Class A beneficiaries are those that have the closest degree of familial relation to the decedent. They include the deceased’s spouse and parents, biological and adopted children, grandchildren, adopted stepchildren, siblings, and various charitable groups. This group of heirs is exempt from all Kentucky inheritance taxes.
- Class B beneficiaries include the entire range of more distant relatives. The group consists of uncles and aunts, nieces and nephews, your children’s spouses, great grandchildren, and half-nephews and nieces. Class B heirs can receive an exemption of $1,000.
- Class C beneficiaries are the most distant heirs, and include all beneficiaries who are not covered by the first two class designations. These heirs are entitled to an exemption totaling $500.
The Tax Rates Are Relatively Straightforward
Like most other states that impose this tax, the Kentucky inheritance tax rates are straightforward and easy to understand. Class A beneficiaries pay no taxes on their inheritances. Class B beneficiaries pay a tax rate that can vary from 4% to 16%. The Class C group can end up paying tax rates anywhere from 6% to 16%. While the difference between those rates might seem negligible, they can represent a substantial amount of money for larger bequests.
Taxes Should Be Filed and Paid Promptly
It’s important to calculate and pay these taxes promptly. In fact, when the inheritance tax is paid within the nine-month period following the death of the decedent, the payee can receive a discount of 5%. In addition, heirs have the option of spreading out their tax obligation over ten installments for bequests that have more than $5,000 in taxes due. There is interest attached to those payments, but it still offers heirs a chance to pay off tax obligations without being forced to liquidate those properties.
You Can Avoid the Problem
The one thing to note is that you don’t have to leave your heirs to pay those bills. The burden of paying inheritance taxes can leave some heirs in uncomfortable positions. If that heir lacks the funds to pay the tax, he or she may have to sell the asset to come up with the money needed to cover those costs.
That can be especially painful when the gift has more than just financial value, but instead carries with it some sentimental value as well. Fortunately, you can use gifting strategies and other techniques to minimize or eliminate inheritance tax liability so that your heirs are not faced with those tough choices. Some strategies include giving away inheritances while you’re still alive or purchasing a life insurance policy to cover those tax costs.