The taxation framework that applies to inheritances is favorable to people that receive bequests for the most part, but high net worth individuals have a cause for concern. We will take a look at taxation from an overview here, but first, we will focus on the capital gains tax.
Step-Up in Basis
“Realizing a gain” is the act of selling an asset after it has appreciated while it was in your possession. If you realize a gain, it is potentially subject to the capital gains tax. Long-term gains are realized more than a year after you acquire the assets.
The rate at which these gains are taxed depends on your taxable income. People that claim $40,400 or less do not pay any long-term capital gains tax. If you make more than this amount and less than $445,850, the rate is 15 percent.
It is 20 percent for the single filers that earn more than $445,850. These figures are in place this year, but they are indexed for inflation after a base has been established via legislative mandate.
The short-term capital rate is equal to your regular income tax rate, and as you would expect, these are gains that are realized less than a year after the acquisition.
If you inherit assets that appreciated while the decedent was still alive, the resources get a stepped-up basis for tax purposes. The meter is reset at the time of acquisition, and you would only be responsible for gains that accumulate in the future.
There may be some changes to these parameters in the near future. A tax plan that came out of the House Ways and Means Committee would increase the rate to 25 percent for single filers that earn at least $400,000. This may seem like bad news, but it is better than the White House proposal, which is 39.6 percent for people with income of $1 million or more.
Federal Estate Tax
The For the 99.5 Percent Act that has been introduced by Senator Bernie Sanders would reduce the federal estate tax exclusion from $11.7 million to $3.5 million. This is the amount that can be transferred tax-free. There would also be an increase in the rate, which would be graduated.
It is currently 40 percent for everyone, and it would be to 45 percent for the first $10 million, and it would top out at 65 percent for estates values at more than $1 billion.
This is a stretch because there is a lot of resistance, but a measure that may actually become a reality in the near future would reduce the exclusion to about $6 million. The change would go into effect at the beginning of the year.
There are also some restrictions on the utilization of grantor trusts for estate tax efficiency purposes in this bill. In light of these pending changes, you may want to schedule a consultation with our firm sooner rather than later if taxation is a source of concern.
State Income and Inheritance Taxes
An inheritance tax is a tax that can be levied on distributions to each individual inheritor when a single estate is being administered. We do not have an inheritance tax on the federal level, but there are six states that have their own inheritance taxes.
California is not one of these six states, but if you inherit property that is located in one of them, it would apply to you if you are not exempt. Close relatives like a spouse, children, grandchildren, siblings, and parents are typically exempt.
There are 12 states with state-level estate taxes, and once again, residents of the Golden State are in the clear, with one caveat. A state-level estate tax would be a factor if you own property in a state with one of these taxes and its value exceeds the exclusion.
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