Some of the most common questions that people have about estate planning revolve around the matter of taxation. Surprisingly, some of the news is rather good, but there is one looming threat that can impact wealthy families. We will provide all the details in this post.
If you were to receive an inheritance from someone, you would not have to report the income when you file your tax returns. This also applies to life insurance proceeds. You would be paid directly by the company, and you would not have to report the check as taxable income.
Capital Gains Tax
The capital gains tax is potentially applicable when you sell an asset that appreciated while you were in possession of it. Short-term capital gains are gains that are realized within one year of the original purchase of the asset. They are taxed at your regular income tax rate.
Long-term capital gains are realized more than a year after you obtain the asset in question.
People that earn $40,400 a year or less do not have to pay any capital gains taxes when they realize a long-term capital gain. The rate is 15 percent for taxpayers that make more than this amount but less than $445,850. For the highest income earners, the rate is 20 percent.
If you inherit assets that appreciated during the life of the person that passed them on, they would get a step-up in basis. This means that you would not be responsible for the gains that accumulated when the decedent was alive.
You would have to pay capital gains taxes if you realize a subsequent gain.
Federal Estate Tax
There is a federal estate tax in the United States, and it can take a heavy toll on your legacy, because it carries a 40 percent maximum rate. Fortunately, very few people have to pay the tax, because there is a high credit or exclusion.
The exclusion is the amount that you can transfer before the tax would be applied. At the time of this writing in 2021, the federal estate tax exclusion is $11.7 million. You will probably see a somewhat higher figure next year when an inflation adjustment is added.
This tax is applicable on transfers to anyone, even your children, with one exception. If you are married to an American citizen, you can use the unlimited marital deduction to transfer any amount of property to your spouse tax-free.
While we are on the subject of spouses, the estate tax exclusion has been portable since 2011. In this context, the term “portability” is used to describe the ability of a surviving spouse to use the exclusion that was allotted to their deceased spouse.
Here in New York, we have a state-level estate tax with a $5.93 million exclusion this year. If your estate will be taxable, we can help you take steps to mitigate the burden.
There is no state gift tax per se, but large gifts that you give within three years of your passing are included in your estate for tax purposes.
Federal Gift Tax
If you are thinking that you can simply give gifts while you are living to avoid the estate tax if you are exposed, that loophole has been closed by the federal gift tax.
It is unified with the estate tax, so the $11.7 million exclusion is a unified exclusion. It applies to large lifetime gifts along with the estate that will be transferred to your heirs after your passing.
In addition to the unified gift and estate tax exclusion, there is an annual gift tax exclusion. You can use this to transfer up to $15,000 to any number of people within a calendar year in a tax-free manner.
If you were to give more than that to any one person, you could give the gift tax free, but you would be using some of your unified exclusion.
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We are here to help if you would like to discuss your estate planning goals with a Smithtown, NY attorney. You can send us a message to request a consultation appointment, and we can be reached by phone at 631-265-0599.