There is some confusion out there about the taxes that can come into play when assets are being transferred after someone dies. This is fully understandable, and we will provide some clarity in this post.
Federal Estate Tax
We have a federal estate tax in the United States, and it is applied to the entire taxable portion of an estate before it is transferred to the heirs.
If you have never thought about the subject, you may assume that everyone has to pay this tax. There are also those that think the term “estate tax” is another way of describing the mandate to report an inheritance when you file your income tax returns.
First, we should emphasize the fact inheritances are not considered to be taxable income by the IRS or the California Department of Tax and Fee Administration.
There is a federal estate tax that applies to postmortem asset transfers. It is very unlikely that your family will ever be forced to pay the tax if you are an average citizen, because there is a high credit or exclusion.
This exclusion can be used to transfer a certain amount before the tax would be levied on the remainder. In 2020, the exclusion is $11.58 million, and this is why so few people actually pay the federal estate tax.
State-Level Estate Taxes
It can be argued that all taxes on inheritances are instances of double taxation. To explain this through the use of a simple example, let’s say that you save a hundred dollars out of every paycheck during your entire working career.
After several decades, the account is pretty hefty. Every penny in that account is money that you have left over after you paid income taxes for each of these years.
If you leave the bank account to your son and a transfer tax of some kind is imposed, would this be fair?
We are touching upon this here because in addition to the federal estate tax, there are quite a few states that have state-level estate taxes. So these after-tax savings could be taxed by the federal government, and the state government.
Here in California, we do not have a state-level estate tax, so we are in the clear, but a Californian could be forced to pay a state estate tax. If you hold property in a state that has its own estate tax, it could be applicable if its value exceeds the exclusion in that state.
Now that we have shared enough background information, we can get to the ultimate point of this blog post. An inheritance tax is not the same thing as an estate tax.
This type of tax would be imposed on transfers to each inheritor that is not exempt when an estate is being administered. There are only six states in the union that have inheritance taxes at this time, and California is not one of them.
However, once again, you could be impacted by one of these taxes if certain circumstances exist.
Kentucky has an inheritance tax, and horse racing fans know that bluegrass country is the epicenter of the thoroughbred breeding world.
If you have a childless wealthy uncle that owned a thoroughbred breeding farm in Kentucky, and he leaves you the farm, the inheritance tax there could be applied on the transfer.
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