By Barry Zimmer on February 18th, 2020 in Estate Planninng
As estate planning attorneys, we notice that people often have questions about taxes on asset transfers. Since Americans are required to report income from just about all sources, you may assume that an inheritance is subject to regular income taxes. If you are under this impression, for once, we can pass along some good news about taxation.
You are not required to claim inheritances as income when you are filing your annual tax returns. This would include insurance policy proceeds, and if you inherit appreciated assets, you get a step up in basis. The value of the inheritance for capital gains purposes would be equal to the value at the time that you received the bequest.
As the inheritor, you would not be responsible for gains that accumulated during the life of the decedent. This being stated, if you hang on to the assets and they continue to increase in value, if you realize a gain, you are on the hook so to speak. We get into specifics about capital gains taxes in another blog post.
The situation with regard to income taxes is favorable, but there are other forms of taxation that can enter the picture. Let’s look at some common questions and answers about transfer taxes so that you can come away with a more complete understanding of the subject.
Okay, so there are no income taxes on inheritances. What about estate taxes?
There is a federal estate tax in this country that can have a significant negative impact on your legacy, because it carries a 40% maximum rate. It is not applicable on the entirety of the estate that you will be passing along to your loved ones, and in fact, most families are not exposed to it at all.
The credit or deduction is the amount that can be transferred before the estate tax would be applied. In 2018, the amount of the exclusion was nearly doubled over what it was the previous year when a new tax package upped the credit to $11.18 million.
This year, the exclusion is $11.4 million, because there are annual adjustments to account for inflation. In 2020, you will probably see a slightly higher figure, and it is important to understand the fact that the entire framework can change if different tax laws are passed in the future.
Are transfers to all family members subject to the estate tax?
The answer to this question is yes and no. This tax can be imposed on transfers to all relatives and others with one exception. If you are married in the eyes of the law, and you and your spouse are American citizens, the estate tax marital deduction can be used to facilitate tax-free transfers.
Can you give gifts to avoid the federal death tax?
Back in the early days when the estate tax was first enacted in 1916, people used to give gifts to their loved ones to sidestep the federal death levy. A gift tax was put into place in 1924 to close the loophole, but it was repealed in 1926.
For a few more years, the gift giving window of opportunity remained open, but it was permanently closed in 1932 when the gift tax was reenacted. During the 1970s, it was unified with the estate tax, so the exclusion is a unified exclusion. It applies to gifts that you give while you are living along with the assets that will be transferred after you are gone.
However, there is an additional gift tax exclusion that is separate from the unified lifetime gift and estate tax exclusion. The annual exclusion allows you to give as much as $15,000 to any number of people in a calendar year free of taxation.
If you give more than this amount to any one recipient, you would be using a portion of your unified lifetime exclusion to give the gift in a tax-free manner. It should be noted that there are additional exemptions that allow you to pay medical bills and school tuition for others without incurring any transfer tax liability.
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