If you receive a direct inheritance through the terms of a will, you would not be required to report it as income on your state or federal tax returns. Distributions of portions of the principal in a living trust are not taxed, but distributions of the earnings would be subject to taxation.
Though income taxes are not a source of concern, there are 12 states in the union that have state-level estate taxes. Fortunately for residents of California, there is no estate tax in the Golden State.
However, this does not mean that a state-level estate tax could not impact someone that is a citizen of California.
There is an estate tax exclusion in these states. This is the amount that can be transferred before the estate tax would be imposed on the remainder.
If you own property in a state that has its own estate tax, and the value of the property exceeds the exclusion amount, the tax would be a factor when your estate is being administered.
The state of Oregon has its own estate tax, and the exclusion is just $1 million. Hawaii is another state with a tax that has an exclusion of $1 million, and there are plenty of Californians that own property in one of these two states.
Six states in the union have an inheritance taxes. Unlike an estate tax, this is a tax on inheritances that are transferred to each individual inheritor.
California is not one of these six states, but there is another consideration. Let’s say that your unattached uncle owns a thoroughbred horse farm in Kentucky. He dies and he leaves the farm to you because he considers you to be the daughter he never had.
There is an inheritance tax in Kentucky, but a surviving spouse, parents, children, grandchildren, and siblings are Class A beneficiaries, and they are totally exempt. As a niece, you would be a class B beneficiary, and the transfer would be taxable under Kentucky laws.
Federal Estate and Gift Tax
While we are on the subject of transfer taxes, we should provide a brief overview view of the federal taxes. The federal estate tax exclusion is $11.7 million in 2021, and the top rate is 40 percent.
Unlimited tax-free transfers between spouses that are American citizens are allowed, but if you leave an inheritance to anyone else, the tax would apply. The estate tax exclusion is portable, so a surviving spouse would be able to use their spouse’s exclusion.
There is also the federal gift tax, and it is unified with the estate tax. As a result of the unification, the exclusion applies to large lifetime gifts and the estate that will be transferred after your passing.
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Cesar has received his Masters of Science in Integrated Design, Business and Technology from the University of Southern California.
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