You may be surprised to hear that you do not have to report an inheritance that you receive through the terms of a will when you file your state and federal income tax returns. This also applies to life insurance proceeds.
Distributions of the principal that is held by a revocable living trust would not be taxable, but you would have to report distributions of the earnings.
If you inherit assets that appreciated during the life of the person that left you the inheritance, they would get a stepped-up basis. You would not be responsible for the gains that accumulated during the life of the decedent, but subsequent gains would be taxable.
Now that we have completed the good news portion of the post, we can move on to the New York estate tax and the 2021 exclusion.
New York Estate Tax Exclusion
There are 12 states in the union that have estate taxes, and New York is one of them. You may not be required to pay the tax, because there is an exclusion that can be used to transfer a certain amount before the tax would be levied on the remainder.
Each year, there are adjustments to account for inflation. The exclusion was $5.85 million last year, and it has been increased to $5.93 million in 2021, but there is a unique twist in New York.
If the value of the estate is more than five percent of the exclusion amount, the entire estate would be subject to the tax.
There is no gift tax in New York, but there is a three-year clawback provision. Large gifts that are given within three years of your passing are considered to be part of your estate for tax purposes.
Federal Estate Tax
While we are on the subject estate taxes, we should take a brief look at the federal estate tax. You can be exposed to the state-level tax and be exempt from the federal estate tax because the federal exclusion is considerably higher.
It stands at $11.7 million this year, but there is going to be a change in the relatively near future. The exclusion is going down to the 2017 figure of $5.49 million adjusted for inflation when a provision contained within the Tax Cuts and Jobs Act sunsets at the end of 2025.
Now that the Democratic Party has the White House and majorities in the House and Senate, the timetable for a reduction in the exclusion amount may be accelerated. This would happen if a new tax act is passed that includes an expansion of the estate tax.
There is a gift tax on the federal level, and the $11.7 million exclusion is a unified exclusion that encompasses large gifts along with your estate. However, there is an additional $15,000 per person annual exclusion that sits apart from the unified lifetime exclusion.
You can give as much as $15,000 to any number of gift recipients within a calendar year free of taxation. If you are exposed to the estate tax, this exclusion can be used to reduce the taxable value of your estate as you transfer assets to your loved ones tax-free.
In addition to the annual exclusion, there are two other ways you can use your assets to benefit others without being taxed for your generosity.
There is an education exclusion that allows you to pay school tuition for students in a tax-free manner. It does not extend to books, fees, and living expenses, but your annual exclusion can be used to provide added support.
A married couple could combine their respective exclusions and provide $30,000 per recipient each year.
The other exclusion can be used to pay medical bills for others, and this applies to the purchase of health insurance for other people.
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If you are exposed to the state and/or federal estate tax, there are steps that can be taken to mitigate your exposure. And of course, if taxes are not a source of concern, we can help you create a custom crafted plan that is ideal for you and your family.
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