You should understand the taxes that can potentially enter the picture when an estate is changing hands. An inheritance is not considered to be taxable income, so this is a positive, and inherited appreciated assets get a step-up in basis.
To explain through the use of an example, let’s say that you inherit stock from your uncle. It is worth $100,000, but he paid $10,000 for the shares many years before his death.
If he would have sold the stock before his death when its value was $100,000, he would have realized a $90,000 gain, and the capital gains tax would be applicable. On the other hand, the assets would get a stepped-up basis when they are transferred to you.
This means that you would not be responsible for the gains that accumulated while your uncle was alive and in possession of the assets.
When it comes to individual retirement accounts, the beneficiary of a Roth account would not have to report the income because these accounts are funded with after-tax earnings.
Traditional individual retirement account holders contribute into their accounts before they pay taxes on the income. As a result, distributions to the original account holder and the beneficiary are subject to taxation.
New York Estate and Gift Taxes
We have a state-level estate tax in the state of New York, but most people do not have to pay it because you can transfer a certain amount tax-free. This threshold is called the exclusion, and in 2021, it stands at $5.93 million.
The rate of this tax is a graduated rate that starts at 3.06 percent, and it maxes out at 16 percent.
You can potentially give gifts to avoid the New York estate tax because there is no gift tax.
However, there is a three-year clawback provision. If you transfer assets out of your name within three years of your death without getting fair value in return, the resources would be part of your estate for tax purposes.
There is a provision in the New York tax code that many people would say is unfair. If the value of your estate exceeds 105 percent of the exclusion amount, the entirety of your estate would be subject to taxation. This is referred to as New York estate tax “cliff.”
Federal Estate and Gift Tax
In addition to the New York state estate tax, people that live in the Empire State should be aware of the federal estate tax parameters. The exclusion on the federal level is $11.7 million this year, and the maximum rate is 40 percent.
This is the highest it has ever been, and it came about as a result of a provision that is contained in the Tax Cuts and Jobs Act of 2017. This provision is going to sunset at the end of 2025, and in 2026, the exclusion will be reduced to $5.49 million.
If you are married, you can use the federal estate tax marital deduction to leave any amount of property to your spouse tax-free. There is also an unlimited marital deduction on the state level.
You cannot give large gifts to avoid the federal estate tax, because there is a gift tax that is unified with the estate tax. The $11.7 million exclusion that we have in 2021 applies to lifetime gifts and your estate.
This being stated, there is an additional $15,000 per person, per year gift tax exclusion. You can give as much as $15,000 to any number of gift recipients in a given year free of taxation before you would have to use some of your unified exclusion to give the gift in a tax-free manner.
There is also an educational exclusion that can be used to pay school tuition for students without incurring any transfer tax responsibility. It is a tuition-only exclusion that does not extend to books, fees, and living expenses.
You could potentially use the $15,000 annual exclusion to provide additional support to a student, and a married couple could combine their exclusions to give as much as $30,000.
There is also a medical exclusion that can be used to pay medical bills for others tax-free, and this exclusion extends to the payment of health insurance premiums for other people.
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If you are ready to work with a Smithtown, New York estate planning lawyer to put a plan in place, we are ready to spring into action. You can send us a message to request a consultation appointment, and we can be reached by phone at 631-265-0599.