Ask Ric: The Hidden Taxes You’re Expected to Pay on Inheritances

The IRS demands you make quarterly payments based on your estimated income – no matter the source

Ric Edelman: Let's take a phone call here on the Truth About Your Future. Let's go out and talk with James. He's in Arlington, Virginia. What can I do to help you?

James S from Arlington, VA: Okay. How many other people find themselves in the same situation: my mother died the second of the two parents, less than a year after my father. And when we split up everything between my brother and I, 50/50, I got about $2.25 million more worth of stock. I was surprised when I did my tax return of how much I owed because I had no withholdings on dividends and capital gains. And one of my firms said, 'Oh, we don't do withholdings'. What are the other ways around that? I asked them to just send me the dividends in capital gains and cash because the IRS is probably, as I understand it, they want estimated payments ahead of time.

Ric Edelman: Yeah, you're right on all counts, number one. First of all, I'm very sorry for your loss. And how wonderful and exciting that your parents have done so well and were able to leave such large bequests to you and your brother. And the most important thing, of course, is the best way you can honor your parents is the proper stewardship of that money. I hope you'll invest and manage the money carefully, but most importantly; I hope you'll take some of it and splurge and go enjoy yourself and drink a toast to your parents as you do. Here's the deal. You're absolutely right. The IRS requires that we pay our taxes as we earn our income. Now, most of us don't ever have to give this any thought because most of us have an income from a job and our employer withholds some of our pay. Sends it off to the IRS on our behalf. And then all we do at the end of the year, when we file our tax return, we settle up, you know, with the IRS. But the bulk of our taxes have already been paid because of our paycheck withholding. But when you're retired, there is no employer. Or if you're self-employed, there is no employer. The IRS, though, still wants their money as you're earning it. So if you're earning dividends and income, if you're earning interest from bank accounts or what have you, if you're earning rental income, if you're earning income from any source in any way, the IRS doesn't say, 'oh, go ahead and earn your income and pay us when you file your return next year'. No, no, no.

Talk to your tax advisor about estimated quarterly filings with the IRS – a “Safe Harbor” approach.

The IRS wants you to pay as you go, so you have to file an estimated quarterly filing with the IRS. It's an estimated quarterly tax, and that means you have to figure out on roughly every three months how much money did I earn over the past three months? And I got to send in an estimate of what the tax liability is going to be. It is a nuisance. There's no two ways about it, and it especially gets worse when people have very fluctuating income. They have no idea how much money they're earning this month or how much they're going to be earning in the next quarter. I don't want to send you a ton of money now when I don't have any income in the next few months. So it's a really challenging issue. One solution is that the IRS gives you a safe harbor. The IRS says, look, if you're really not sure how much you're going to owe us this year, tell you what, pay us now what you paid us last year. And then we'll call it even. We'll let you true it up when you actually file your return next April. So you want to talk with a tax advisor who can help you figure out either how much am I earning right now and how much do I owe right now for my estimated filing? Or how do I file based on the safe harbor rule of how much I owed a year ago? But you're right, there's really no other alternative. Brokerage accounts are generally not going to withhold on your behalf, and there's really no choice but for you to file an estimated quarterly return with the IRS.

James S from Arlington, VA: Yeah, my withholdings are from my retired pay. So when the investments were small, the dividends, capital gains, the Schedule B income was a small percentage of it for 2021...Surprise! It's about as much as the income for which there was withholdings against.

Ric Edelman: Yeah, you're now in a situation that your investment income is so large, the taxable income, the dividends and the capital gains are now so significant, it's forcing you to deal with quarterly estimated tax payments. There's really no way to avoid it. It's part of the penalty of being wealthy.

James S from Arlington, VA: Okay. So, yeah, I talk to my firms who have it and see if I can move money around or minimize taxes. That really is maximize wealth and minimize taxes.

Ric Edelman: That's everybody's goal. And few of us ever succeed in getting away with both of those. Some of us are pretty good at maximizing wealth. Others are pretty good at minimizing tax. It's hard to do both.

James S from Arlington, VA: Tax exempt bonds or Roth IRAs are a good way to way to avoid that. But when stocks do well, you have a big gain. You've got to pay tax on it.

Ric Edelman: Yeah, you've got the deal. There's no magic elixir. There's no secret formula that I can share with you other than make the money, pay the tax, and move on.

James S from Arlington, VA: Okay. Thank you.

Ric Edelman: Thank you so much for calling. That was James in Arlington, Virginia. And you can do what James did. Got a question for me? Just write to AskRic@theTruthAYF.com Warning...you might not like the answer I give you.

Thanks to our sponsors this week:

Visit GlobalXETFs.com to learn how thematic investing can complement your portfolio or ask your financial advisor

Get started investing in digital assets with the Bitwise 10 Crypto Index Fund (BITW)

Learn about investing in Invesco QQQ -- a fund that allows you to access the innovators of the Nasdaq 100

Take your wealth potential to the next level and schedule a free no-obligation meeting with an Edelman Financial Engines advisor

New investors can get $101 to split across the top 5 stocks in the S&P 500 when they open a new account with the Schwab Starter Kit

See how it’s possible to invest in Bitcoin, crypto and other alternative assets inside your IRA with Choice by Kingdom Trust