For the most part, inheritances are not subject to taxation because there are no income taxes on direct bequests. There is a step-up in basis for inherited appreciated assets, so an inheritor is not responsible for capital gains that accumulated during the life of the decedent.
However, there is a tax that can have a major impact if you have been very successful from a financial standpoint. We have a federal estate tax in the United States, and it can take a major bite out of your legacy because it carries a 40 percent top rate.
2022 Estate Tax Exclusion
The tax is only a factor for high net worth individuals because there is a multimillion dollar exclusion. This is a set amount that can be transferred before the estate tax would be levied on the part of an estate that exceeds this amount.
In 2017, the exclusion was $5.49 million, and the Tax Cuts and Jobs Act was enacted at the end of that year. It doubled the exclusion with an inflation adjustment, so the figure went up to $11.18 billion for 2018, and it is indexed for inflation annually.
We have heard a lot about inflation this year because it has been somewhat significant. The 2022 estate tax exclusion amount has been released, and it is going to be $12.06 million.
There is no estate tax on transfers between spouses because there is an unlimited marital deduction. The estate tax exclusion was made portable when a piece of legislation was passed at the end of 2010, and this means that the surviving spouse can use their deceased spouse’s exclusion.
Federal Gift Tax
You cannot simply give large gifts to avoid the estate tax because there is a gift tax in place that is unified with the estate tax. The $12.06 million exclusion that we will see next year applies to your estate and gifts that you give during your life.
However, you get somewhat of a break. There is an additional gift tax exclusion that can be used to give a certain amount to any number of gift recipients each year tax-free.
To be clear, you would not use any of your multimillion dollar exclusion to give a gift tax-free as long as the gift does not exceed the limit. It has been $15,000 per year, per person since 2018, but it is going up to $16,000 next year.
Action Is Required
If you are exposed to the federal estate tax, you should consider utilizing your exclusion to give gifts while it is at a record high. In addition to direct gifts, you can use the exclusion to fund certain types of trusts that provide estate tax efficiency.
The reason why action is required is because the exclusion is going to go down in the very near future. On January 1, 2026, the provision in the Tax Cuts and Jobs Act that established the exclusion is going to expire or sunset.
In 2017, the exclusion was $5.49 million as we have stated, and it will go back down to this level indexed for inflation when the aforementioned Tax Cuts and Jobs Act sunsets.
We can help you utilize your exclusion to its greatest advantage if you engage us to help you implement an estate tax efficiency strategy.
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