In many ways, the tax laws that pertain to postmortem asset transfers are favorable to inheritors. You do not have to report an inheritance on your income tax returns, and if you inherit appreciated assets, you get a step-up in basis. For capital gains purposes, you would not be responsible for appreciation that accumulated during the life of the decedent.
There is the end of the tax story for most people, but high net worth individuals have some other taxes that can have a very significant impact, and we will look at them here.
Federal Estate Tax
There is a federal estate tax in the United States that carries a hefty 40 percent maximum rate. Fortunately, there is a credit or exclusion that can be used to transfer a certain amount before the tax would kick in. In 2020, the federal estate tax exclusion is $11.58 million.
It should be noted that there is an unlimited marital estate tax deduction. If you are married to an American citizen, you can leave any amount of property to your spouse in a tax-free manner.
On the subject of spouses, the estate tax exclusion is portable. This means that a surviving spouse could use the exclusion that was allotted to their deceased spouse.
The federal estate tax was enacted in 1916, and at that time, there was no gift tax. As a result, people used to give gifts to avoid the death tax, but a gift tax was put into place in 1924. This tax was repealed two years later, but it was reenacted for good in 1932.
It was unified with the estate tax during the 1970s, so the $11.58 million exclusion that we have this year is a unified exclusion. It applies to lifetime gifts along with the estate that will be transferred after you are gone.
Other Gift Tax Exemptions
In addition to the unified exclusion, there are three other gift tax exemptions that can be utilized. One of them is the $15,000 per year, per person gift tax exemption. You can give this amount to any number of people every year free of the tax.
This can be utilized to transfer a good bit of money in a tax-free manner if you take advantage of it for an extended period of time. For example, let’s say that you are married and you have three married children. You and your spouse could give a total of $30,000 to each husband and each wife.
This would be a transfer of $180,000 tax-free every year, and you could do this over an extended period of time. Direct gift giving is a possibility, but you can also use this gift tax exemption to fund certain types of trusts that provide estate tax efficiency.
There is an educational exemption that you can use to pay school tuition for students without being taxed for your trouble. It should be noted that you would have to pay the institution directly, and this exclusion does not extend to books and fees.
The other exclusion is a medical exemption. You are not taxed if you pay medical bills for others, and this includes health insurance premiums for the benefit of someone else.
New York State
We have a state-level estate tax here in New York, and the exclusion is $5.85 million. There is no gift tax, but there is a three-year claw-back provision. The value of gifts that you give in the three years preceding your death would be added to your estate for tax purposes.
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