Taxation would logically enter your mind when you are contemplating your legacy, and most of the news is surprisingly good when it comes to taxes on inheritances. First, an inheritor does not have to report a bequest as taxable income, and appreciated assets that are inherited get a step-up in basis.
What is a step-up in basis, you ask? The best way to explain is by way of a simple example. Let’s say that your grandfather bought some stock that cost him a total of $10,000, and he leaves you the stock in his will. It is now worth $100,000, so there was a $90,000 gain.
If he sold the assets before he passed away, he would have been responsible for capital gains taxes on the realization of the gain. However, since he never realized a gain, you would receive a step-up in basis. For tax purposes, the value of the stock would be equal to its value when you assumed ownership of it, so you would be in the clear from a capital gains perspective.
Of course, if you hold on to the stock and it continues to increase in value above and beyond the $100,000, you would be responsible for future gains.
Estate Tax
Moving on to the next form of taxation, there is a federal estate tax in the United States, but most families do not have to worry about it. This is because there is a large exclusion or credit that allows you to transfer a certain amount in a tax-free manner. In 2019, the exact amount of this exclusion is $11.4 million.
We should point out the fact that there is an unlimited marital deduction. You can transfer any amount of property to your spouse free of the estate tax, as long as your spouse is a citizen of the United States.
On the subject of spouses, the estate tax exclusion is portable. From an estate planning perspective, this means that if you predecease your spouse, you could utilize their exclusion along with your own. Using the figure that is in place for 2019, the spouse would have a total exclusion of $22.8 million.
There are some states in the union that have state-level estate taxes. The exclusions in these states can be much lower than the federal exclusion. As a result, it would be possible to face state-level estate tax exposure even if your assets do not exceed the amount of the federal exclusion.
We do not have an estate tax on the state level in California where we practice law. However, if you happen to own property in a state that does have an estate tax, it could be a factor for you. This is something that you can discuss with an attorney from our firm if you own valuable property in another state or states.
You cannot simply give gifts to your loved ones to get around the estate tax, because there is a gift tax in place. The exclusion is a unified exclusion that includes large gifts that you give throughout your life coupled with the value of the estate that will be transferred after your death.
Inheritance Tax
As a layperson with no professional interest in the subject of estate planning, it would be natural to assume that the terms “inheritance tax” and “estate tax” are interchangeable ways to describe the same thing. In fact, this is not the case at all.
An inheritance tax is applied on transfers to each individual inheritor that is not exempt, so there could be multiple impositions of an inheritance levy when one estate is being administered. An estate tax is applied on the total taxable amount before it is transferred to the heirs.
There is no federal inheritance tax, but there are a handful of states in the union that have state-level inheritance taxes. In fact, Maryland has a state-level estate tax and a state inheritance tax. Here in California, there is no inheritance tax.
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