Colorado Inheritance & Estate Tax: How 99% Can Avoid [+ IRS Pitfalls]

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Paul Sundin, CPA

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Since Colorado does not impose either inheritance or estate taxes on the state level, most of the Centennial State`s residents don`t have to worry about the financial burden when they become heirs.

However, since some states still do have their local inheritance taxes and the federal taxation is relevant to all residents of the United States and their properties, a Colorado resident may still become responsible for a certain tax due in case of inheritance.

In this article, we shall walk you through the peculiarities of American inheritance and estate taxes and describe the most efficient part to protect your inheritance from taxes.

How does inheritance tax work for Colorado residents?

Technically, there is only one case where a Colorado resident would have to pay an inheritance tax. It happens only if they inherit an estate from a state that still levies local inheritance taxes that apply to the out-of-state heirs as well.

So, if you are about to inherit property from someone who lives in Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania, it is better to learn the inheritance tax regulations of those 6 states in advance.

However, Colorado residents may have to face some fiscal burdens even if they inherit property within the state. It happens if the inherited estate exceeds the Federal Estate Tax exemption of $12,06 million.

An estate tax is imposed on the property before it is being transferred to heirs. Considering the progressive rate that can reach up to 40%, the Federal Estate Tax may significantly reduce tour heirdom.

That is why thorough estate planning is essential for those who have sufficient assets and wish to preserve them for their heirs, even if they live in Colorado or any other state without inheritance taxes.

How to reduce the taxable part of an estate in Colorado?

Colorado is also among the states that don`t levy a local gift tax. It is good news for those who may need to reduce the taxable part of their estate as they can simply gift away its shares to the heirs presumptive.

However, you should still remember about the Federal Gift Tax that won`t let a Colorado resident simply write the taxable part of their estate over to one heir in one act.

Nevertheless, the Federal Gift Tax has an annual exclusion amount of $16,000. It means that anyone can make up to $16,000 for gifts to as many people every year. It is the most efficient and convenient way for Colorado residents to fit their estate into the frame of the Federal Estate Tax exemption.

Except for gifting shares of your estate directly to heirs throughout several years, you can reduce its taxable parts by making gifts that are not considered taxable even if they exceed the annual $16,000 limit:

  • Donations made to IRS-approved charity funds;
  • Payments for medical treatment or education once are made directly to the organization or institution that provides the service;
  • Gifts between two spouses who are both US citizens.

Due to the absence of gift tax in Colorado, the state`s residents can easily reduce the taxable part of their estate, preserving it for the heirs. However, depending on the overall worth of your assets and the number of heirs, the procedure may take decades and require qualified advisory and assistance.

Any way you look at it, the earlier you start the estate planning procedure, the bigger are your chances to pass your whole legacy to the beloved ones without any damaging fiscal burden. 

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