Since you pay taxes on income, you may wonder if you have to report an inheritance that you may receive when you file your income tax returns. The answer is no, in general your inheritance will not be subject to income taxes.
However, if you inherited something that subsequently appreciated, the appreciation could be taxable.
As the recipient of the inheritance, you don’t have to pay income taxes. But, taxation can be a factor when you look at the big picture.
There is an estate tax in place, but there is a $5.43 million exclusion in 2015. If the total value of the estate in question exceeded this amount, the estate itself would potentially be subject to the estate tax.
If you were entitled to a particular percentage of an estate that was subject to the estate tax, your inheritance would be reduced, though you would not be directly taxed as an individual. So in a real sense, your inheritance is indeed taxed under these circumstances.
A layperson may assume that an inheritance tax and an estate tax are the same thing. In fact, these terms are not interchangeable.
The estate tax is levied on the entirety of the estate in question. For example, let’s say that Joe has an estate valued at $15.43 million. Because of the $5.43 million exclusion, only $10 million of this is subject to the estate tax. The estate tax carries a maximum rate of 40 percent.
We will assume that Joe did not do anything to mitigate his estate tax exposure. He has four children who will be splitting the estate equally.
The 40 percent estate tax will be applied to this $10 million. The tax man would absorb $4 million. This would leave $6 million that would be split among the four children.
An inheritance tax is something that is entirely different. This type of tax is levied on each person who is receiving an inheritance. It is not levied on the entirety of the estate before inheritances are distributed.
Fortunately, we do not have an inheritance tax on the federal level. There are some states that do have an inheritance tax on the state level. As a resident of California, you don’t have to worry about your heirs paying inheritance taxes, because there is no state-level inheritance tax here in the Golden State.
Tax Efficiency Strategies
Most families won’t be exposed to the estate tax, and there is no inheritance tax in California. However, if your total assets exceed $5.43 million in value, you are exposed to the federal estate tax.
The good news is that there are steps that you can take to mitigate your exposure. To learn about estate tax efficiency strategies, contact our firm to schedule a free consultation.