As estate planning attorneys, taxation is one of the subjects that we are asked about the most, and this makes sense. The Internal Revenue Service seems to want to know about every penny that finds its way into your pocket so you would assume that this would extend to inheritances.
Plus, most people have heard about the existence of estate taxes so they assume that taxation comes with the territory. In this post, we will provide some clarity, with an emphasis on appreciated assets (assets that have gone up in value), the capital gains tax, and the step up in basis.
Regular Income Taxes
Generally speaking, an inheritance does not have to be reported as income on your tax returns. This includes direct bequests that you receive through the terms of a last will, and it also extends to insurance policy proceeds.
Transfer on death or payable on death accounts are bank accounts that have a beneficiary. After the death of the primary account holder, the beneficiary would assume ownership of assets in the account. These transfers also would not be subject to taxation.
Estate and Inheritance Taxes
We have a federal estate tax in the United States, and it carries an attention-getting 40% maximum rate. That’s the bad news, but the good news is that it is only applicable on transfers that exceed $11.4 million.
This figure is called the exclusion, and it will be somewhat higher next year when an inflation adjustment is applied. It should be noted that there is no tax on transfers between citizens who are married to one another because there is an unlimited marital deduction.
Some states in the union have state-level estate taxes with exclusions that are lower than the federal exclusion. We practice in Kentucky and North Carolina, and there are no state-level estate taxes in these states.
You could however face exposure if you have valuable property in a state with an estate tax, even if you are not a resident.
There are six states that have inheritance taxes, and this type of tax is different from an estate tax because it is applied on transfers to each nonexempt inheritor. As luck would have it, Kentucky is one of them, but surviving spouses, children, parents, grandchildren, and siblings are exempt.
Capital Gains Tax
Now that we have looked at the other forms of taxation, we can get to the point of this blog post. The capital gains tax can apply if you sell appreciated assets (or assets that have increased in value). In tax lingo, when you do this, you are “realizing a gain.”
There are two different classes of gains: long-term and short-term capital gains, and they are taxed at different rates. In general, a short-term gain is a gain that is realized within one year of the original acquisition of the asset. These gains are taxed at you regular income tax rate.
As you may have guessed, a long-term gain is a gain that is realized more than a year after you originally purchased the assets. If you make no more than $39,375 a year, you would not be subject to the capital gains tax if you realize a long-term gain.
For people that make between $39,376 annually and $434,550 per year, the rate is 15%. For people that go over the maximum threshold for the 15% bracket, the rate is 20% at the present time.
If you inherit assets that appreciated while they were being held by the person that left you the bequest, you would not have to pay any capital gains taxes on the amount the assets increased in value before the person died because you would get a step up in basis. This means that for capital gains purposes, the value of the assets would be equal to the value at the time the person died.
However, you would be responsible for any gains that you realize going forward if you do not immediately liquidate the assets.
Attend a Free Seminar!
We invite you to attend one of our upcoming seminars that are going to cover a number of different important estate planning and elder law topics. You don’t have to buy any tickets because the sessions are free, but we do ask that you register in advance.
To do just that, visit our seminar schedule page and follow the simple instructions. If you have any questions, we can be reached by phone at 704-944-3245 in North Carolina (Charlotte, NC and Huntersville, NC), and our Kentucky number is 606-324-5516 for Ashland, KY, or 859-372-6655 for Florence, KY .
John’s practice focuses on the use of Wills and Living Trusts in Estate Planning to help individuals protect their families and preserve their legacies after their deaths, but his practice also focuses on the critical issues of protecting individuals with dementia or other diminished capacity, assisting individuals in qualifying for Medicaid and other government benefits to offset the costs of long-term care, and providing special needs planning.
John is admitted to practice law in North Carolina, South Carolina, Kentucky, and Ohio, and he is accredited by the Department of Veterans Affairs.
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