Generally speaking, inheritances are not subject to regular income taxes. Plus, inherited assets get a step up in basis. This means that the person receiving the inheritance does not have to pay capital gains taxes on the appreciation that accumulated during the life of the decedent.
The above is good news, but there is also some bad news to pass along with regard to taxation. We have a federal estate tax in the United States, and it can do a lot of damage to your legacy. This death tax carries a maximum rate of 40 percent, so we are talking about a very significant chunk.
There is an estate tax credit or exclusion that you can use to transfer a certain amount of money and/or property to your heirs in a tax-free manner. Back in 2001, it was just $675,000, so many people were exposed to the estate tax. To add to the misery, the top rate was 55 percent.
It gradually went up to $3.5 million in 2009 due to provisions contained in pieces of tax legislation. The tax was completely repealed in 2010, but it returned in 2011 with a $5 million exclusion. This figure was retained with annual adjustments to account for inflation through 2017.
At the end of that year, a round of tax cuts was approved by Congress and signed into law by the president, and the law had a significant impact on the federal estate tax exclusion. In 2018, the exclusion went up to $11.18 million. This year, it stands at $11.4 million because of an inflation adjustment. To be clear, only the portion of your estate that exceeds the amount of exclusion would be taxed.
Another thing to understand is the fact that there is an unlimited marital deduction. You can use this to transfer unlimited assets to your spouse in a tax-free manner. This is true if you are married to a United States citizen. The unlimited deduction is not available to non-citizen spouses.
Speaking of spouses, the estate tax exclusion is portable between married couples. In this context, portability refers the ability of a surviving spouse to use the exclusion that his or her deceased spouse was entitled to utilize. Using the numbers that are in place for 2019, a surviving spouse would have a total exclusion of $22.8 million if none of it was used by the deceased spouse.
Federal Gift Tax
When you hear about the existence of the federal estate tax, a simple idea would naturally come to mind. You could give assets to loved ones that will be inheriting them anyway when you are still alive to avoid the estate tax. This was possible for several years after the estate tax was first enacted in 1916.
The loophole was closed by the installation of a federal gift tax in 1924. It was repealed a couple of years after that, but it was reenacted in 1932, and it has been in place ever since then. The estate tax and the gift tax are unified, so the exclusion is a unified exclusion that applies to your estate and large gifts that you give while you are still alive.
We used the qualifier “large” gifts for reason. There is another gift tax exclusion that sits apart from the unified gift and estate tax exclusion. This is the annual gift tax exclusion that allows you to give up to $15,000 to any number of people each year tax-free.
In addition to the annual gift tax exclusion, there are a couple of other exemptions that can be utilized. If you want to pay school tuition for a loved one or anyone else, the gift tax would not be applicable. Books, fees, and living expenses are not covered under this exclusion, but you could provide additional support by using your annual gift tax exclusion.
The other gift tax exclusion that we have is a health care exclusion. You are allowed to pay medical bills for others without being taxed for your generosity. This would include the payment of health insurance premiums.
Attend a Free Seminar!
Since you are on this site, you must be looking for information about estate planning. We are glad that you are here, and there are many useful resources on our website. Plus, if you want to take your knowledge to another level, we are offering a number of opportunities in the near future.
Our attorneys are holding a seminar series, and you can learn a great deal if you attend one of these sessions. There is no charge at all, but we do ask that you register in advance so we can reserve your seat. To get all the details, click the following link: Macomb County Estate Planning Seminars.