People often have questions about how taxes impact inheritances, and most of the news is good. Generally speaking, an inheritance that is received through the terms of a will or a life insurance policy would not be subject to regular income taxes.
An exception would be distributions of the earnings that are generated by assets in a trust. Plus, distributions to traditional individual retirement account beneficiaries are taxable because the accounts are funded with pretax earnings.
Inherited appreciated assets get a stepped-up basis, so the value for capital gains purposes is equal to the value at the time of acquisition. The inheritor is not responsible for gains that took place during the life of the decedent, but they would be on the hook for future gains.
Federal Estate Tax
There is a federal estate tax that is irrelevant to most people because the exclusion is higher than the value of the vast majority of the estates. The credit or exclusion is a set dollar amount that can be transferred tax-free before the estate tax would be levied on the remainder.
When the Tax Cuts and Jobs Act was enacted in December of 2017, it raised estate tax exclusion from $5.49 million to $11.18 million for 2018. This figure has remained in place indexed for inflation, and the exclusion this year is $11.7 million.
This level will be retained through 2025, but on January 1, 2026, the exclusion is scheduled to go back down to $5.49 million. The For the 99.5 Percent Act that has been introduced into the Senate would reduce the exclusion to $3.5 million, but there will be a great deal of resistance.
If you are married, you can transfer unlimited assets to your spouse tax-free as long as your spouse is an American citizen. The exclusion has been portable since 2011, so a surviving spouse can use their deceased spouse’s exclusion.
Federal Gift Tax
It would be easy to get around the estate tax if you can just give gifts to your loved ones while you are living. This was the way that it was after the estate tax was enacted in 1918. People would just give gifts to sidestep the tax.
In 1924, a gift tax was enacted to close the window of opportunity, but it was repealed in 1926. It was reenacted in 1932, and we have had a federal estate tax since then.
The multimillion dollar exclusion is a unified exclusion that applies to lifetime gifts along with your estate. So if you give $11.7 million in taxable gifts this year, and you pass away before the new year rolls around, all of your estate would be subject to the estate tax.
Aside from this unified exclusion, there is a separate $15,000 annual gift tax exclusion. The first $15,000 that you give to someone can be transferred tax-free without using any of your unified lifetime exclusion.
To be clear, you can give away an unlimited amount of money each year tax-free as long as you do not give more than $15,000 to any one person.
In addition to the annual exclusion, there is another exclusion that allows you to pay medical bills and health care insurance premiums for others tax-free. The education exclusion give you the ability to pay school tuition for students in a tax-free manner.
Illinois State Estate Tax
There are 12 states that have state-level estate taxes, and Illinois one of them. The state-level exclusion this year is $4 million, so this tax could be a factor for you even if you are exempt on the federal level.
That’s the bad news, but the good news is that there is no gift tax on the state level, so you could give gifts while you are living to mitigate your estate tax exposure.
Attend a Free Workshop!
The best way to learn a lot while you are making an initial connection with our firm is to attend one of our estate planning workshops. There is no charge, and you can visit our workshop schedule page to obtain details and registration information.
Need Help Now?
If you are ready to work with a Naperville, IL estate planning lawyer to put a plan in place, we are here to help. In addition to our location in Naperville, we will be opening an office in North Aurora soon, so stay tuned.
You can set up a consultation appointment if you call us at 630-568-8611, and you can use our contact form if you would rather send us a message.
- Using Disclaimers to Achieve Client Goals: Double Disclaimers - December 2, 2021
- “Last Will and Testament” Origin - November 26, 2021
- How to Dispose of “Stuff” - November 19, 2021
Leave a Reply