You probably have questions about how taxes can impact the inheritances that you are going to leave to your loved ones, including the capital gains tax. In this post, we will share information about taxes on capital gains and we will provide a broader overview of taxation on inheritances.
Step-Up in Basis
The best way to explain how capital gains taxes apply to inheritances is to provide a hypothetical example. Let’s say that your wealthy uncle Pete passes away, and he leaves you shares of stock that increased in value considerably while he was living.
Uncle Pete paid $100,000 for the shares, but they are worth $500,000 when you inherit them. If he would have sold the stock while he was living, he would have paid the capital gains tax on $400,000 in gains. He knew this, and he had a plan.
Your uncle left the stock to you in part because he knew that you would not have to pay the capital gains tax on the appreciation. The assets get a step-up in basis, and the basis for you is not $100,000; it is $500,000, so you pay no capital gains taxes on the inheritance.
If you sell the assets in the future after they are worth more than $500,000, you would be responsible for those gains from a tax perspective.
With regard to the rate of capital gains taxes, short-term gains are realized less than a year after the acquisition of the assets. These gains are taxed at your regular income tax rate, and the long-term rate is variable depending on your income level.
People that claim $44,625 or less do not have to pay long-term capital gains taxes, and the rate is 15 percent for people that make more than this amount but less than $492,300. If you claim more than $492,300, you would pay a 20 percent rate as the laws stand right now.
You do not have to pay taxes on an inheritance under most circumstances. An exception would be distributions of a trust’s earnings because they have not been taxed previously.
Distributions from inherited traditional individual retirement accounts would be taxable because these accounts are funded with pre-tax earnings. The tax situation is reversed for Roth accounts, so beneficiaries and the original account holders do not report distributions as income.
The federal estate tax is not a factor for most families because you can transfer $12.92 million tax-free. This figure is called the credit or exclusion, and it is at this level because of a provision in the Tax Cuts and Jobs Act of 2017. That measure will sunset at the end of 2025. If there are no legislative changes between now and then, the exclusion will be $5.49 million in 2017 dollars indexed for inflation in 2026.
Transfers between spouses are not taxable because there is an unlimited marital deduction, and a surviving spouse can use their deceased spouse’s exclusion.
There are 12 states with state-level estate taxes, but South Carolina is not one of them. However, if you own valuable property out of state, if there is an estate tax in that state, it would apply to your estate. That is, if its value exceeds the exclusion in the state it is located in.
Take Action Today!
Even if you are not exposed to estate taxes, you should work with an attorney to develop a plan that ideally suits your situation. There are different approaches that can be taken, and you should become apprised of your options so you can make the right choices.
If you are ready to get started, you can schedule a consultation appointment at our Bluffton, SC estate planning office if you call us at 843-815-8580. There is also a contact form on this site you can use if you would prefer to send us a message.