Some people are confused about taxes that enter the picture when assets are transferred after someone dies. The terms “estate tax” and “inheritance tax” are used, and there are state and federal levels to consider.
In this post, we will provide an explanation so you can go forward with a firm understanding of taxes on inheritances as a Connecticut resident.
Estate Tax vs. Inheritance Tax
The best place to start is to look at the core differences between an estate tax and an inheritance tax. An estate tax is levied on the entire taxable portion of an estate before it is distributed to the heirs, so there would be just one instance of taxation.
There will typically be an estate tax credit or exclusion that represents an amount that can be transferred before the tax would become applicable. This exclusion exists because estate taxes target wealthy individuals that are in a position to transfer wealth from generation to generation.
Different folks have different opinions with regard to what makes a person “wealthy” in this context, but that’s a matter for the lawmakers to sort out.
An inheritance tax is a different form of taxation. This tax is levied on distributions to each individual inheritor when an estate is being administered. An inheritance tax does not necessarily target high net worth families exclusively, but there can be exceptions.
Federal Gift and Estate Tax
There is no federal inheritance tax, but there is a federal estate tax that is unified with the federal gift tax. The exclusion in 2020 is $11.7 million, and it encompasses large gifts and the estate that will be transferred after your passing.
If you are legally married, you can transfer any amount of property to your spouse tax-free, and the exclusion is portable. This means that a surviving spouse can use the exclusion that was earmarked for their deceased spouse.
In addition to the unified gift and estate tax exclusion, there is an annual gift tax exclusion. You can give as much is $15,000 to an unlimited number of people in a given calendar year tax-free without using any of your unified exclusion.
There is an educational exclusion as well. If you want to pay school tuition for others, there is no gift tax to pay, and there is an exclusion that applies to the payment of medical bills and health insurance premiums.
State-Level Estate and Gift Taxes
There is a state-level estate tax in Connecticut with a $7.1 million exclusion in 2021. Connecticut is the only state in the union that has a gift tax, and the taxes are unified.
State-Level Inheritance Taxes
There is no federal inheritance tax, and there are just six states that have inheritance taxes. These states are Maryland, Iowa, Nebraska, Kentucky, Pennsylvania, and New Jersey. Maryland actually has an inheritance tax and a state-level estate tax.
If you inherit property that is located in one of these states, it would be a factor for you, even if you are a Connecticut resident. However, close relatives like children, grandchildren, and spouses are typically exempt.
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