People naturally have questions about how inheritances are taxed, and some of the answers are encouraging. You do not have to claim an inheritance on regular income tax returns, and this would include insurance policy proceeds along with direct inheritances.
Another positive on the tax front is the concept of the step-up in basis. If you inherit assets that appreciated during the life of the person that left you the money, you would not be responsible for capital gains taxes on those gains. You would incur capital gains liability if you realize additional gains after you have assumed ownership of the assets.
Federal Estate Tax
Though the taxation dynamic is quite positive for most Americans, the lay of the land is entirely different for high net worth individuals. There is a federal estate tax that looms large with an imposing 40 percent maximum rate. It can be applied on transfers that exceed $11.58 million.
This figure represents the estate tax credit or exclusion in 2020. There can be annual adjustments to account for inflation, and it should be noted that the entire structure can be changed via legislative mandate.
There is an unlimited marital deduction that can be used to transfer any amount of money to your spouse free of taxation, but transfers to anyone else are taxable. Because the estate tax exclusion is portable, a surviving spouse could use the exclusion that was allotted to their deceased spouse.
As an Ohio resident, at some point along the way you may have heard about the existence of a state-level estate tax in our state. There was an additional estate tax to contend through 2012, but it was repealed for deaths taking place on or after January 1, 2013.
If you happen to own property in a state that has its own estate tax, that tax could apply to your estate.
Federal Gift Tax
Now that we have shared the requisite background information, we can get to the specific point of this post. If your estate is going to be subject to the estate tax, you do not avoid taxation if you give large gifts while you are living. There is a federal gift tax in place, and it is unified with the estate tax.
The exclusion is a unified exclusion that applies to lifetime gifts along with the estate that will be transferred after your death. However, you can give unlimited gifts each year in a tax-free manner, because there is an annual gift tax exclusion that sits apart from the unified exclusion.
This amount is also subject to change, but at the current time, you can give as much is $15,000 to any number of gift recipients within a calendar year free of taxation. If you give the maximum amount to multiple different people are on your inheritance list, it can add up over time.
In addition to the annual gift tax exclusion, there are a couple of other ways that you can divest yourself of assets while you are living in a tax-free manner. There is an educational exemption that allows you to pay school tuition for students without incurring any tax liability.
It is a tuition-only exclusion, and the funds must be to paid directly to the institution. Of course, you could use your $15,000 per year annual exclusion to provide additional support.
There is a medical exemption as well, and this allows you to pay health care bills for others without being taxed for your generosity. This exemption extends to the payment of health care insurance premiums.
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