Long Island Elder Law & Estate Planning

capital gains taxWe are going to look at the guidelines for capital gains taxes on inheritances in this post. But before we focus in on that subject, we will provide a general overview of taxation as it applies to your estate.

State and Federal Income Taxes

Since the taxman always wants a piece of the pie, a lot of people assume that you would have to claim an inheritance as taxable income. In fact, this is not the case, and there is a rationale behind this arrangement.

To explain through the use of a simple example, let’s say that you save 1/10 of your take-home salary for 20 years. You put it in a bank account, and you leave the bank account to your son.

The money was part of the remainder that you had left after you paid taxes on your income. If your son had to claim the inheritance as income, it would be an instance of double taxation.

This logic makes a lot of sense, but it is thrown out the window when it comes to estate taxes as we will explain in another section.

Individual Retirement Accounts

Though there are some hybrids, generally speaking, there are two different types of individual retirement accounts that are typically utilized: traditional accounts, and Roth IRAs.

If you have a traditional account, you make contributions before you pay taxes on the income. As a result, when you take distributions, they are looked upon as taxable income. This would also apply to a beneficiary of the account.

A Roth individual retirement account is funded with after-tax income, so distributions to the original account holder or a beneficiary are not subject to taxation.

Estate and Gift Taxes

There is a federal estate tax in the United States that has a 40 percent maximum rate, but it is only a factor for very high net worth families.

At the time of this writing in 2020, the exclusion is $11.58 million. This is the amount you can transfer before the estate tax would be applied on the remainder.

There is a gift tax that is unified with the estate tax, so the $11.58 million exclusion that we have this year is a unified exclusion. It applies to large gifts along with the estate and will be transferred after you are gone.

Here in New York where we practice law, there is a state-level estate tax with a $5.85 million exclusion this year. There is a graduated rate that maxes out at 16 percent.

We have an estate tax exclusion “cliff” in New York. If the value of your estate exceeds the exclusion amount by more than 5 percent, you would fall off the cliff, and the entirety of your estate would be taxable.

There is no gift tax on the state level, but there is a three year clawback provision. Any gifts that you give within three years of your passing are considered to be part of your estate for tax purposes.

Capital Gains Tax and the Step-Up in Basis

Now we can take a look at the capital gains tax. If you inherit assets that appreciated during the life of the person that left you the inheritance, you would get a step-up in basis. This means that you would not be forced to pay capital gains taxes on those gains.

The capital gains tax would be a factor if you retain ownership of the assets and you sell them at a later date after they have appreciated.

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About Mark S. Eghrari, Estate Planning Attorney

Mark S. Eghrari is an attorney in private practice in Smithtown, New York. He has been in practice since 1988. Mark S. Eghrari provides extensive estate and tax planning services to individuals and businesses. Mr. Eghrari’s primary focus is helping clients avoid probate, minimize or eliminate Federal and State Estate taxes and protect their assets from the high cost of nursing care, if they become ill.