Many people assume that you have to pay regular income taxes when you receive an inheritance. In fact, this is not the case at all. Inheritances are not looked upon as taxable income, and if you inherit appreciated assets, you get a step up in basis. This means that you do not have to pay capital gains taxes on the appreciation and took place during the life of the person that left you the inheritance.
That’s the good news, but the bad news for high net worth individuals is the fact that there is a federal estate tax in place. The reason why we say that it is bad news for the wealthy only is because most people do not have to pay the tax since there is a relatively high credit or exclusion. This is the amount that you can transfer before the estate tax would be applied.
At the time of this writing in 2018, it stands at $11.18 million. There may be a slight adjustment next year to account for inflation. Everything that you transfer that is above this amount would be subject to the tax, with one exception. You are allowed to transfer unlimited assets to your spouse free of the estate tax, as long as your spouse is an American citizen.
While we are on the subject of the estate tax and married couples, we should explain the portability factor. If you are married, and you predecease your spouse, your spouse would be able to utilize your exclusion along with his or her own. Using the figure that is in place this year, a surviving spouse would have a total exclusion of $22.36 million.
Federal Gift Tax
When you hear about the existence of the federal estate tax, if you are wealthy enough to face exposure, you may consider giving gifts to your loved ones. You would essentially be giving them their inheritances in advance. This is not as simple as it sounds, because there is a federal gift tax in place along with the estate tax.
The two levies are unified, so the $11.18 million is a unified exclusion that encompasses large lifetime gifts along with the estate that will be transferred after you are gone. As a result, if you were to utilize all of your exclusion giving gifts while you are living, the entirety of your estate would be subject to the death tax.
This being stated, there is a way that you can give limited gifts without using any of your unified gift and estate tax exclusion. In addition to the exclusion that we have been explaining to this point, there is an annual gift tax exclusion. It allows you to give a certain amount to any number of different recipients during a calendar year free of taxation. Right now, the amount that you can give tax-free is $15,000 per person.
If your estate is in taxable territory, you could use this exclusion to divest yourself of a considerable amount of money tax-free as you reduce the value of your estate. This exclusion is allotted to each individual, so you and your spouse could give $30,000 to an unlimited number of people each year. Let’s say that you have five married children. You could give $30,000 to each husband and each wife, and in all, you would be giving away $300,000 every year in a tax-free manner.
There are a couple of additional gift tax exclusions that you could consider utilizing to assist loved ones without incurring any transfer tax liability. If you want to pay medical bills for others, you can do this free of taxation, and this medical exemption includes health care insurance premiums.
You may also pay school tuition for students without being taxed for your generosity. However, this is a tuition-only exemption that does not cover lodging, food, books, fees, etc. However, you could utilize your $15,000 per person annual gift tax exclusion to provide a student, or multiple students, with additional support.
Attend a Free Seminar!
We passed along some useful information about the federal estate and gift taxes in this brief blog post, and we have another fantastic learning opportunity to present to you. Our estate planning attorneys are holding a number of seminars over the coming weeks, and you can learn a great deal if you attend the session that fits into your schedule.
The sessions are free, but we do ask that you register in advance so that we can reserve your seat. To get all the details, cruise over to our seminar schedule page and click on the date that works for you.