One of the things that would naturally enter your mind when you are planning your estate is the question of taxation. Will your heirs be required to pay taxes on inheritances that you leave to them? For the most part, the answers are encouraging, but there is one looming threat to your legacy.
The Good News
Inheritances are not considered to be taxable income by the IRS, so an heir does not have to claim an inheritance on regular income tax returns. Another positive applies to the capital gains tax.
The best way to explain this is through the utilization of a simple example. Let’s say that your uncle leaves you a thousand shares of stock, and they are selling for $100 a share when you inherit them. That’s a $100,000 inheritance.
He bought the stock many years before he died at $10 a share. Your uncle was a wise man, because he paid $10,000 for shares that were worth $100,000 when he passed away.
If he was to sell the shares while he was still alive, he would have to pay the capital gains tax on the $90,000 profit. You as the inheritor would not have to pay any capital gains tax at all, because you would get a step up in basis.
For capital gains purposes, the meter would begin anew after you obtain ownership of the shares, and no taxes would be due. Of course, if you were to maintain ownership of the stock, and it was to continue to grow in value, you would be responsible for future gains.
The Bad News
On the not so pleasant side of the street, there is a form of taxation that can have a very significant negative impact on inheritors. There is a federal estate tax in the United States, and it carries a heavy 40 percent maximum rate.
Since there is an unlimited marital deduction, you can transfer any amount of money to your spouse free of taxation, but all other transfers are subject to this tax. However, there is an estate tax exclusion or credit that can be used to decrease the taxable value of your estate.
At the time of this writing in 2020, it stands at $11.58 million. The federal estate tax would only be applied on the portion of the estate that exceeds this amount. It should be noted that the estate tax exclusion is portable, so a surviving spouse would have two exclusions available.
In Connecticut, we have a state level estate tax to contend with as well. In 2020, the exemption is $5.1 million, and the maximum rate is 12 percent. There is a ceiling on the maximum amount that can be levied, and during the current calendar year, it is $15 million.
There is a federal gift tax, and there is also a Connecticut state gift tax. The exclusions apply to large lifetime gifts along with your estate, so you would be using part of your exclusion to give tax-free gifts while you are still living.
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