Generally speaking, income from all sources must be reported to the IRS and the state tax authorities when you file your annual returns. Many people that have knowledge of the subject assume that you would be required to pay income taxes on an inheritance.
In reality, this is not the case. When you inherit assets that accumulated after taxes were paid on the income, you do not have to report the inheritance as income, because another imposition would be double taxation.
This being stated, it is possible to inherit assets that were never taxed, and you would have to report that income. Traditional individual retirement account beneficiaries are in this position, because these accounts are funded with pretax income.
The untaxed earnings that are generated by assets that have been conveyed into a trust would be taxable income when they are distributed to a beneficiary.
Capital Gains Taxes
We will use an example to explain the way capital gains are treated when assets are being inherited. Let’s say that your father bought $10,000 of stock 25 years before his death. He had a good eye, and the stock is worth $500,000 when you inherit it.
You have a very big capital gains tax bill on your hands, right? In fact, you would be off the hook, because the assets would get a stepped-up basis. In a real sense, the gains that accumulated while your father owned the assets will never be taxed.
The meter is reset at $500,000 when you inherit the assets. If you maintain possession of them, and they appreciate beyond the basis of $500,000, you would be required to pay the capital gains tax if and when you realize a gain.
Federal Estate Tax
So far, the news that we have shared has been encouraging, but there is a federal estate tax that will dampen your mood if you have been very successful financially. This tax carries a 40 percent top rate, and it is imposed on the portion of an estate that exceeds the exclusion.
In 2021, the exclusion is $12.06 million, and it is indexed annually for inflation. This level will hold sway through 2025 because of a provision that is contained in the Tax Cuts and Jobs Act that was enacted in December of 2017.
The provision will sunset when the clock strikes midnight on December 31st, 2025. In 2026, the exclusion will be $5.49 million indexed for inflation unless some new tax legislation is passed in the meantime that alters the trajectory.
There is a gift tax that is unified with the estate tax, and it was enacted in 1932 to stop people from giving gifts to get around the estate tax. You would be using some of your unified gift and estate tax exclusion to give a large tax-free gift.
When you digest this information, you can see that you have a limited window during which you can use the record high exclusion to give tax-free gifts. You should definitely consider action if your estate is going to be exposed, and the funding of a trust is another option.
State-Level Estate Taxes
There are a dozen states in the union that have state-level estate taxes, and there is a Washington, D.C. estate tax. South Carolina is not one of these 12 states, but your estate could be subject to a state-level estate tax if you own valuable property in a state with an estate tax.
The state-level exclusions are lower than the federal exclusion. There are estate taxes in Massachusetts and Oregon with $1 million exclusions, so you should consult with us if you own valuable out of state property.
Attend a Free Webinar!
We conduct webinars on an ongoing basis that cover estate planning and nursing home asset protection. The sessions are free, and you can join us from anywhere, so you should definitely take advantage of the opportunity.
You can see the dates if you visit our webinar page, and if you decide to attend, follow the instructions to register.
Need Help Now?
If you have already learned enough to know that you should work with a Hilton Head, SC estate planning lawyer to put a plan in place, there is no time like the present. You can send us a message to request a consultation appointment, and we can be reached by phone at 843-815-8580.
Hunter is a member of the South Carolina Bar Association, the Beaufort County Bar Association, and has served on charitable and advisory boards in the Bluffton/Hilton Head area.
Hunter graduated from Hilton Head High School. He then earned his Bachelor of Science Degree in Economics from Clemson University, in Clemson, South Carolina.
Hunter graduated Cum Laude from Regent University School of Law in Virginia Beach, Virginia, having earned a Juris Doctor Degree. He also wrote his doctorial thesis on Estate Planning Dynasty Trusts.
Hunter has called Beaufort County home for since 1984, where he lives with his wife and two children.In his spare time he dabbles in automobiles, reading history, hunting and fishing.
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