When you are planning your estate, you may wonder about the way that taxes can impact inheritances that you are leaving to your loved ones. We will take a look at the details in this post to shed some light.
Income Taxes
Many people are pleasantly surprised when they learn that you do not have to claim an inheritance on your federal or state income tax returns. This applies to insurance policy proceeds along with direct bequests.
When it comes to revocable living trusts, distributions of the principal balance would not be subject to regular income taxes. Disbursements of income that was generated by the trust are subject to taxation.
Capital Gains Tax
Capital gains taxes can be applicable when appreciated assets are sold. In tax and accounting circles, this is called “realizing a gain.”
The best way to explain the estate planning implications is through the utilization of a simple example. Let’s say that your grandfather bought 1,000 shares of stock for $10 a share. Many years later, the stock is worth $50 a share.
He put out $10,000 to buy the shares initially, and the value went up to $50,000. If he was to sell the stock, he would have to pay capital gains tax on the $40,000 gain.
However, if he passes away and leaves you the stock in his will, you would get a step up in basis. You would not be responsible for the gains that accumulated during the life of your grandfather. The new basis would be $50,000 going forward, so you would be responsible if you realize a gain beyond that basis.
Federal Estate Tax
We have a federal estate tax in the United States, but most people never have to pay it, because there is a very high credit or exclusion. This is the amount that can be transferred tax-free, and in 2020, it stands at $11.58 million. The top rate of the tax is 40 percent.
There is a federal estate tax marital deduction that allows you to transfer property of any value to your spouse tax-free, as long as your spouse is an American citizen. The estate tax exclusion is portable, so a surviving spouse would be able to use the exclusion that was allotted to their deceased spouse.
It should be noted that there is a federal gift tax in place that is unified with the estate tax. This levy exists to prevent people from giving large lifetime gifts in an effort to avoid the tax. The exclusion is a unified exclusion that applies to gifts combined with estate transfers.
One caveat to this would be that you are allowed to give up to $15,000 to an unlimited number of gift recipients within any calendar year free in a tax-free manner.
State-Level Estate Tax
There are some states in the union that have estate taxes on the state level. The exclusions in these states are usually much lower than the federal exclusion. Fortunately, there is no California estate tax, but if you own property in a state that has its own tax, it could be a factor.
Inheritance Tax
A lot of people assume that the terms “inheritance tax” and “estate tax” are interchangeable ways of describing the same type of tax. In fact, there are differences.
An estate tax is applied on the entirety of the taxable portion of an estate before it is distributed to the heirs. With an inheritance tax, there could be levies on distributions to each individual inheritor.
There is no federal inheritance tax, and there is no California inheritance tax. A small handful of states do have this type of tax, and for your information, Maryland has both an estate tax and inheritance tax.
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