www.loubar.org 12 Louisville Bar Briefs Kentucky Inheritance Tax: Pitfalls & Planning Opportunities Matthew H. Burnett and Monica B. Davidson Kentucky is one of six states—soon to be five—which imposes an inheritance tax. An inheritance tax is a tax on a beneficiary’s right to receive property from a deceased person. The more distant the relationship between the deceased person and the beneficiary, the higher the tax rate. Contrast this with the bet- ter known estate tax, which is a tax based on the value of the property owned by a deceased person at their death. Some, particularly non-exempt beneficiaries, may argue that Kentucky’s imposition of an inheritance tax makes us unusual in a bad way (hence the proposed House Bill 308 which, if passed in its current state, would repeal the inheritance tax for those dying after August 1, 2024). Regardless of one’s thoughts on the virtues of the tax, attorneys, executors and beneficiaries should all make sure they have a cursory understanding of the tax in order to avoid cumbersome estate administrations, unnecessary penalties and interest payments, and disgruntled clients. Kentucky Inheritance Tax: Brackets and Beneficiaries Kentucky Revised Statutes Chapter 140 cre- ates the Kentucky inheritance tax. As with many tax statutes, KRS 140 is clunky and difficult to comprehend on first read (and on second read, and third read for this author). Fortunately, the Kentucky Department of Revenue has a plethora of helpful materials available online at www.revenue.ky.gov. The amount of inheritance tax owed is dependent on the relationship between the beneficiary inheriting the property and the deceased person who owned the property at their death. The more distant the relationship, the higher the tax bracket. Kentucky divides beneficiaries into three classes: Class A (fully exempt), Class B (less exempt) and Class C (least exempt). Class A beneficiaries consist of spouse, parent, children (biological, step and adopted), grandchildren (can be issue of biological child, adopted child or stepchild), siblings (whole or half), and educational, religious and charitable institutions. Class B beneficiaries consist of nieces and nephews (half or whole), children-in-law, aunts, uncles and great-grandchildren (issue of biological, step or adopted child). Class C beneficiaries – the highest bracket – consists of everyone else not listed in Class A or Class B. Class B beneficiaries hit a top marginal tax rate of 16% on inheritances of $200,000 or more, and Class C beneficiaries hit the top marginal tax rate of 16% on inheritances of $60,000 or more. For example, a $200,000 inheritance left to a nephew would incur a $22,960 inheritance tax liability, and a $200,000 inheritance left to a cousin would incur a $28,670 inheritance tax liability. These are significant tax liabilities which should be discussed with i) clients during the estate planning process, and ii) executors/admin- istrators and beneficiaries during the estate administration process. Pitfalls and Planning Attorneys should make sure they are hav- ing detailed conversations with their clients regarding potential Kentucky inheritance tax liability. First, many clients may be surprised to learn that Kentucky imposes an inheritance tax, and some may alter how their estates are to be distributed once they are informed of the tax. Clients could be rightfully upset to learn that a significant portion of their estates could wind up in the hands of the Kentucky Department of Revenue simply due to the na- ture of the relationship between the client and the intended beneficiary. Many have closer relationships to nieces, nephews, cousins or more distant relatives than they do to their parents or siblings, and they would be justi- fied in feeling that they are being arbitrarily penalized for these relationships. Better that the client have this conversation with their counsel prior to executing their Wills than for the client to learn of this information after the fact from a third party. Second, the attorney and client should discuss how the client would like to handle payment of any inheritance tax liability. Generally, inheri- tance tax is paid out of the share received by a beneficiary. For example, if a cash bequest of $25,000 were left to a nephew (Class B beneficiary) a tax of $1,160 would be owed, so the nephew would ultimately receive $23,840 from the estate. However, some clients may want any inheritance tax liabilities to be paid as a general debt of the estate. Continuing with the example above, if the client included a provision in their Will for any inheritance taxes to be paid as a general debt of the estate, the nephew would receive the full $25,000 be- quest, and the inheritance tax liability would be paid by the executor as a debt of the estate. How the client decides to allocate payment of inheritance tax has implications for how simple the administration of the estate will PROFESSIONAL EXCELLENCE Visit clio.com or scan the QR code Louisville Bar Association members save more than time with Clio. 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