One of the first questions that people ask about the process of estate planning revolves around taxation. Do you have to pay taxes on an inheritance that you receive? In this post, we will address this question from every direction and provide you with the appropriate answers.
Income Taxes
The Internal Revenue Service wants to know about income from every imaginable source, so it is natural to assume that an inheritance would be taxable. In fact, this is not the case at all. You do not have to report an inheritance when you file your income tax returns.
Capital Gains Tax
If you sell assets that appreciated while you had them in your possession, you would be “realizing a gain” in tax parlance. When these events take place, the capital gains tax will become applicable. The tax is broken up into two different categories.
Short-term gains are gains that are realized less than a year after you originally acquired the asset in question. These gains are taxed at your regular income tax rate. Long-term gains are realized more than a year after the original acquisition of the resources.
The rate for long-term gains will vary depending on your regular income tax bracket. People in the lowest bracket do not pay this tax at all. Most taxpayers would apply a 15 percent rate, and the wealthiest among us would be looking at a 20 percent capital gains rate.
Now that you understand the tax, if you inherit assets that appreciated during the life of the person who left you the money, the assets would get a step-up in basis. For capital gains purposes, the value would be equal to the value at the time that you acquire the assets. As a result, you would have no capital gains responsibility.
Federal Estate Tax
So far, we have been sharing good news, but this section is a mixed bag. We do have a federal estate tax in the United States, but a very small percentage of Americans are exposed to the tax. This is because there is a significant credit or exclusion.
The exclusion is the amount that can be transferred before the estate tax becomes applicable. During the current calendar year, the federal estate tax exclusion stands at $13.61 million. Regardless of the value of your estate, there will be no tax on transfers to your spouse, because there is an unlimited marital deduction.
You cannot give large gifts to loved ones while you are living to avoid the estate tax because there has been a gift tax in place continuously since 1932. It is unified with the estate tax, so the exclusion is a unified exclusion that encompasses large gifts along with your estate.
We should point out the fact that there are 12 states with state-level estate taxes, and New Jersey is not one of them.
Inheritance Tax
It would be natural to assume that the term “inheritance tax” is just another way of referring to the estate tax. In fact, this is actually a separate form of taxation. An inheritance tax can potentially be imposed on inheritances that are being transferred to each individual inheritor.
There is no federal inheritance tax, but there are five states with state-level inheritance taxes. We do have a state-level inheritance tax in the Garden State, but close relatives are exempt.
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