Before we look at the step-up in basis and a potential change that looms over the horizon, we should take a look at the broader tax picture.
Most of the things that you need to know about how taxes can influence inheritances are surprisingly positive. An inheritance is not looked upon as taxable income by the IRS or state tax authorities, and this applies to insurance policy proceeds and direct bequests.
If you bequeath an individual retirement account to a beneficiary, the distributions would not be taxed if it is a Roth account. They would be subject to taxation if it is a traditional account, but this is only fair because you contribute into a traditional IRA before taxes are paid on the income.
Estate and Inheritance Taxes
There is an estate tax in the United States, but very few people have to pay it. At the time of this writing, it is levied on the portion of an estate that exceeds $11.58 million in value.
Some states have state-level estate taxes. We have offices in North Carolina and Kentucky, and there are no state estate taxes in these states.
Inheritance taxes and estate taxes are two different types of taxation. An inheritance tax can be imposed on transfers to multiple different inheritors when one estate is being administered. There is no federal inheritance tax, and there are just six states that have state-level inheritance taxes.
Unfortunately, Kentucky is one of these states. That’s the bad news, but the good news is that Class A beneficiaries are completely exempt from the tax. These are close relatives including a surviving spouse, parents, children, grandchildren, brothers, and sisters.
Capital Gains Tax and the Step-Up in Basis
Now that you have a pretty good understanding of the taxes that can and cannot be a factor when an estate is being transferred, we can get to the point of this post.
If you own assets that have appreciated while they have been in your possession and you realize a gain, the capital gains tax applies. In this context, the term “realize” refers to the act of selling the asset in question.
There are short-term gains and long-term gains. A short-term gain is realized if the asset is sold less than a year after it was acquired, and a long-term gain is realized if the asset is sold more than a year after the original acquisition.
Short-term gains are taxed at your regular income tax rate, and the long-term rate depends on your gross taxable income.
Individual filers that claim $40,000 or less are exempt from long-term capital gains taxes. Taxpayers that earn more than this but less than $441,450 are in the 15 percent bracket. The tax rate for individuals that claim more than $441,450 is 20 percent.
Do you have to pay the capital gains tax if you inherit assets that appreciated during the life of the person who left you the inheritance? The answer is no because you would get a step-up in basis. You would not be responsible for those gains, but the tax would apply if you realize future gains from increases in the value after the person’s death.
As you might imagine, the use of the step-up in basis is a very effective estate planning strategy for certain individuals. Joe Biden’s platform includes a modification or elimination of the step-up in basis so it may go away if he wins the election and he has sufficient support from members of Congress.
If you have constructed your estate plan with the intent to use the step-up in basis to your advantage, action may be required if Biden gets the nod.
Schedule a Consultation Today!
Our doors are open if you are ready to discuss your estate planning goals with a licensed attorney. You can send us a message to request a consultation appointment, and if you reach out this way, you can expect to receive a prompt response.
If you would rather give us a call, our office in Ashland, Kentucky can be reached at 606-324-5516, the number for the Florence, Kentucky office is 859-372-6655, and the number for our Charlotte, North Carolina and Huntersville, North Carolina locations is 704-944-3245.