For the most part, the news is good when it comes to taxes on inheritances. You do not have to claim a direct inheritance on your regular income tax returns, and this includes insurance policy proceeds.
Inherited appreciated assets get a stepped-up basis. The person inheriting the asset is not responsible for gains that accumulated during the life of the decedent. They would be on the hook for future appreciation if and when they realize a gain.
On the bad news front, there are estate taxes to contend with, and there has been a change to an important Connecticut state estate tax detail for 2021.
The exclusion is the amount that can be transferred tax-free before the estate tax would be applied on the remainder. In 2020, the estate tax exclusion in Connecticut was $5.1 million.
This year, it has been increased to $7.1 million. The rate is a graduated rate, and there are six brackets that start at 10 percent, and they max out at 12 percent for estates valued at $10,100,001 or more.
There is a maximum amount of tax that can be paid on a single estate in Connecticut, and this figure is $15 million for deaths that occurred after January 1, 2019.
Connecticut is the only state in the union that has a state-level gift tax, so you cannot give gifts to avoid the tax. The $7.1 million exclusion that we have this year applies to lifetime gifts as well, so if you give this much in tax-free gifts while you are living, the entirety of your estate would be taxable.
We should put out the fact that there are a total of 12 states that have estate taxes. If you are a resident of Connecticut, and you own property in a different state with an estate tax, that tax would be a factor if its value exceeds the exclusion.
Our regional neighbors in Vermont, New York, Rhode Island, Massachusetts, and Maine have estate taxes. There are also people that have vacation homes in Hawaii, and there is an estate tax in the Aloha state.
Federal Estate Tax
While we are on the subject of estate taxes, we should provide a review of the federal estate tax parameters for 2021. The exclusion on the federal level is considerably higher than the Connecticut state exclusion. This year, the federal exclusion is $11.7 million.
On the federal level, there is a maximum rate of 40 percent, so when you combine this with the state estate tax, you are looking at a very significant level of taxation.
There is also a federal gift tax that is unified with the estate tax. The $11.7 million exclusion that we have in 2021 encompasses your estate along with large lifetime gifts.
If you are married, you can use the unlimited marital deduction to transfer any amount of property to your spouse tax-free. Of course, the IRS doesn’t lose anything in the long run, because your spouse would be in possession of a taxable estate.
On the subject of spouses, the estate tax exclusion is portable. A surviving spouse can use the exclusion that was earmarked for his or her deceased spouse. This is a relatively new provision that was established after the enactment of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (H.R. 4853).
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