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inheritance planning and taxes

When you start to explore the subject of taxation on any level, you generally don’t discover a lot of positives. However, when it comes to the subject of inheritance planning, you are looking at a mixed bag when it comes to taxation.

In this blog post, we will pass along some good news, some bad news, and some downright ugly news about taxation.

The Good

Since the Internal Revenue Service requires you to report income that you receive from virtually any source, you may naturally expect that you would have to report an inheritance as income when you file your annual tax returns. In fact, an inheritance is not considered to be taxable income, so an inheritor is in the clear on that level.

There is also the matter of capital gains taxes and the step-up in basis. This tax can be applicable when a gain is realized. You realize a capital gain if you sell an appreciated asset and pocket the proceeds.

The gains are divided into two different categories. Short-term capital gains are realized less than a year after your original purchase of the asset, and these gains are taxed at your regular income tax rate. If you sell an appreciated asset more than a year after you acquire it, you would be realizing a long-term capital gain. Top income earners pay a maximum long-term capital gains rate of 20 percent, but most people pay 15 percent.

If you inherit assets that appreciated while they were in the possession of the person who left you the inheritance, you do not have to pay capital gains taxes on the gains that took place during the life of the decedent. The assets get a step-up in basis, so the value of the assets for capital gains purposes would be equal to the value when you acquired them.

You would however be responsible for capital gains if the assets continue to appreciate after they are in your possession and you ultimately realize a gain.

The Bad

Now we have to head over to the other side of the ledger. There is a federal estate tax that can play havoc with your legacy if you have been particularly successful from a financial standpoint.

If you are an American citizen who is married to another citizen, you don’t have to worry about the estate tax, because there is an unlimited marital deduction. Transfers to any other person could potentially be subject to taxation.

The federal estate tax carries a 40 percent maximum rate, and it could be applied on asset transfers that exceed the amount of the federal estate tax credit or exclusion. In 2016, the federal estate tax exclusion is $5.45 million.

When you are tallying up the value of your estate, you have to include all of the real property that you own, and life insurance policy proceeds would also be part of your estate for tax purposes.

If your estate is going to be exposed to the federal estate tax, there are steps that you can take to mitigate your exposure. Various different types of irrevocable trusts are utilized, and there are other techniques that can be implemented to preserve your wealth for the benefit of your loved ones.

The Ugly

The federal estate tax looms large for high net worth individuals, but things can get uglier for people who reside in certain states. There are 14 states in the union that impose state-level estate taxes. The District of Columbia also has its own estate tax.

People who live in these states could potentially be subject to the federal estate tax and a state-level estate tax. Plus, since the state-level exclusions are typically lower than the federal exclusion, a person who is exempt on the federal level could be exposed on the state level.

Our primary practice is in the state of Florida, and there is no state-level estate tax in our state. However, we also practice in New Jersey and New York, and both of these states do impose state-level estate taxes. Even if you live in Florida, if you own valuable property in a state with an estate tax, the tax in that state could be applicable.

Finally, there are also a handful of states that have state-level inheritance taxes. New Jersey is one of them, so this is another tax that can enter the picture if you are a resident of the Garden State.

Attend a Free Seminar

If you would like to learn more about taxes and other important inheritance planning matters, attend one of our free seminars. The seminars are held on an ongoing basis, and you can visit our seminar schedule page to get all the details.

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