When you start to focus on the process of estate planning, the subject of taxation will naturally come to mind. We are going to provide a broad overview here with an emphasis on capital gains taxes and a potential change that would have a damaging impact.
Many people are surprised to hear that you do not have to report an inheritance as income when you file your state and federal tax returns. This applies to direct inheritances along with life insurance proceeds.
The beneficiary of an individual retirement account may or may not be required to pay taxes on the distributions. If your inherited account is a traditional IRA, the distributions would be subject to taxation, but distributions from a Roth individual retirement account would be tax-free.
Estate and Inheritance Taxes
There is good news and bad news to report about estate and inheritance taxes. We have a federal estate tax in the United States, but very few people have to pay it, because there is an $11.58 million exclusion or credit. It is not a factor for you unless the value of your estate exceeds this amount.
A number of states in the union have state-level estate taxes, but Ohio is not one of them. However, if you own property that is located in a state with an estate tax, that tax would be a factor if its value exceeds the exclusion.
State-level exclusions are typically lower than the federal exclusion, but they are still higher than the value of most estates. Oregon and Massachusetts have $1 million exclusions, and those are the lowest in the states that have state-level estate taxes.
An inheritance tax can be applied on transfers to each individual inheritor, and an estate tax is levied on the entire taxable portion of an estate before it is distributed to the heirs.
We do not have a federal inheritance tax in the United States, but six states have state inheritance taxes. Once again, we are in the clear here in Ohio.
This is another tax that can impact out-of-state residents. If you inherit property in state with an inheritance tax, it would be a factor for you unless you are exempt. In the six states that have inheritance taxes, close relatives are totally exempt.
Capital Gains Tax
Now we can narrow our focus to look at the capital gains tax. If you inherit assets during the life of the person that left you the inheritance, you get a step up in basis. You would not be responsible for the gains that accumulated during the life of the decedent.
Once you take possession, the capital gains meter would start running, and you would be on the hook for capital gains taxes if you realize a gain in the future.
Wealthy people that are in possession of appreciated assets routinely use the step-up in basis to their advantage. We have a presidential election coming up, and Democratic candidate Joe Biden has proposed an elimination of the step-up in basis to raise revenue that would be used to expand health care.
This is a matter that you should keep an eye on if you have an estate plan in place that relies upon the utilization of the step-up in basis.
Access Our Free Estate Planning Worksheet
We have prepared an estate planning worksheet that you can use to gain a more thorough understanding of the process. This is a free resource, so you should definitely take advantage of this opportunity to build on your knowledge.
To get your copy, visit our worksheet access page and follow the simple instructions.
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If you are ready to put an estate plan in place, or if your existing plan is in need of a revision, we are here to help.
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