We are going to address a question that is on the minds of some people that have a good grasp on federal transfer taxes. Before we drill down to it, we will provide some background information for those that do not fully understand taxes on inheritances.
The Good News
There is some surprisingly good news on this subject, which is rare when you are talking about the tax man.
If you are named as an inheritor in a will, you would not be required to report the income when you file your federal and state tax returns. This applies to insurance policy proceeds as well.
The beneficiary of a living trust would not pay taxes on distributions of the principal, but interest earnings that are distributed would be taxable. When it comes to undistributed interest, the trust itself would be required to declare the income.
Traditional individual retirement account holders make pre-tax contributions, so they have to pay taxes on the distributions, and this applies to the beneficiaries.
With Roth IRAs, the accounts are funded with after-tax earnings. As a result, distributions to the original account holder or a beneficiary are not subject to taxation.
Inherited appreciated assets get a stepped-up basis for capital gains purposes. Inheritors are not responsible for the gains that took place during the life of the decedent.
Federal Estate Tax
Inheritances are not subject to regular income taxes because an additional tax would be an instance of double taxation. After all, and estate is comprised of assets that remain after taxes were paid throughout the decedent’s life.
This logic goes out the window when it comes to people that have had a great deal of financial success. There is a federal estate tax that carries a 40 percent rate, and it is applicable on the portion of an estate that exceeds the exclusion.
In 2021, the federal estate tax exclusion is $11.7 million, so a small percentage of people are exposed this tax.
2021 Annual Gift Tax Exclusion
Now that we have set the stage appropriately, we can get to the point of this post. There has been a gift tax in place since 1932 to stop people from giving gifts to avoid the estate tax, and the two taxes are unified under the tax code.
The $11.7 million exclusion that we have touched upon is a unified exclusion applies to lifetime gifts and the estate that will be transferred after you are gone.
However, there is an additional annual gift tax exclusion that sits apart from the unified exclusion. You can use it to give a certain amount to any number of gift recipients each calendar year free of taxation.
Last year, it was $15,000, so people that have transfer tax concerns were hoping for an increase to account for the cost of living. Unfortunately for them, there has been no change, so the exclusion will remain steady at $15,000 per gift recipient.
There is also an educational exclusion that can be used to pay school tuition for others without being taxed. It does not extend to books, fees, and living expenses, but the annual exclusion can be used to provide additional support.
Another gift tax exclusion that flies under the radar is the medical exclusion. You are not exposed to the gift tax if you pay medical expenses for others, and this includes health insurance premiums.
Attend a Free Seminar
We are conducting a series of seminars over the coming weeks, and you can come away with a lot of useful knowledge if you join us for one of the sessions. There is no admission charge, but we ask that you register in advance so we can reserve your spot.
You can see the dates if you visit our seminar page, and when you identify the one that works for you, follow the simple instructions to register.
Need Help Now?
If you have already learned enough to know that it is time for you to work with an attorney to put an estate plan in place, we are here to help. You can send us a message to request a consultation appointment, and we can be reached by phone at 860-548-1000.
Mr. Nirenstein is licensed to practice before the courts of the State of Connecticut and the United States District Court. He is a member of the Connecticut and Hartford County Bar Associations, and the Estate and Probate, Elder Law, Business Law and Real Estate Sections of the Connecticut Bar Association.
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