The capital gains tax can be imposed when you sell assets that appreciated after you acquire them. This is called “realizing a gain,” and there are short-term gains that are realized less than a year after the acquisition, and long-term gains are realized more than a year after you obtain the assets.
Long and short-term gains are taxed at different rates. A short-term gain is taxed at your regular income tax rate, and long-term gain rates are based on your income. People that claim $40,400 or less are exempt from long-term capital gains taxes.
The rate is 20 percent for filers with income that exceeds $445,850, and it is 15 percent for those that are in the middle of these two extremes. The budget bill that is being worked on in Congress would increase the top rate to 25 percent for people claiming $400,000 or more.
Inherited Appreciated Assets
What happens with someone dies when they are in possession of assets that appreciated while they were living? They never realized a gain, so no capital gains taxes were paid.
You may assume that the person that inherits the appreciated assets would have to pay the capital gains tax on the previous gains, but this is not the case. The assets would get a stepped-up basis, and the new basis would be equal to the value of the assets at the time of acquisition.
If the assets are sold at a later date after future appreciation has accumulated, the capital gains tax would be applicable.
Income Taxes on Inheritances
Inheritances are not considered to be taxable income by the IRS or the New York estate tax authorities because the decedent already paid taxes. For example, if you put some of your salary into a savings account, you are setting aside a portion of the after-tax income.
Another imposition of income taxes when an inheritor takes possession of the assets would not be fair. However, there are some postmortem transfers that involve assets that have never been taxed.
The earnings that are generated by assets in a trust would fit into this category, so you have to claim distributions of the earnings when you file your taxes. This would also apply to distributions to a traditional individual retirement account beneficiary.
We have a federal estate tax that packs a punch with 40 percent rate. That’s the bad news, but the good news is that you probably do not have to be concerned about it because there is a large exclusion.
You can transfer this amount tax-free, and anything that exceeds it would be taxable. For the rest of 2021, the exclusion is $11.7 million.
The budget reconciliation bill that we have all been hearing so much about over recent months includes a reduction in the exclusion. It would go down to just over $6 million at the beginning of 2022 if it is enacted, so this is a matter you should monitor if it will impact your estate.
Lifetime gift giving would be a good way to get around the estate tax, but there is a gift tax that is unified with the estate tax, and this closes the loophole.
Here in New York, we have a state-level estate tax with $5.93 million exclusion this year. Unfortunately, there is a peculiar phenomenon in our state that is referred to as New York state exclusion “cliff.”
If your estate is valued at more than five percent over the exclusion amount, the entirety of your estate would be subject to taxation. There is no gift tax on the state level, but large gifts that you give within three years of your passing are considered to be part of your estate for tax purposes.
Eleven states outside of New York have state-level estate taxes, and if you own valuable property in one of these states, it would apply to your estate.
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If you are ready to work with a Smithtown, NY estate planning lawyer to put a plan in place, our doors are open. You can call us at 631-265-0599 to set up an appointment, and you can use our contact form if you would rather send us a message.