You should understand the taxation factors when you are planning your estate and let your family know what they can expect. We are going to look at the capital gains tax as it applies to inheritances here, and we will go on to provide a broader overview.
Step-Up in Basis
If you are in possession of appreciated assets, you have to pay capital gains taxes if you realize a gain. This is the act of selling the asset and pocketing the profit. From an estate planning perspective, this raises an interesting question: are appreciated inherited assets taxable?
The answer is no, because the assets would get a stepped-up basis. For the purposes of the capital gains tax, there would be a new basis that is equal to the value of the assets at the time of acquisition. This can be a significant tax break, and many people take advantage of it intentionally.
There are short-term capital gains that are realized less than a year after the asset was acquired, and there are long-term gains, and they are taxed at different rates. For short-term gains, the rate is equal to your regular income tax rate.
Long-term rates depend on your income level. People that earn $40,400 or less are exempt from long-term capital gains taxes. Those that make more than this much but less than $445,850 pay a 15 percent rate. Others are taxed at a 20 percent rate, but that may change.
At the time of this writing, Congress is working on a tax bill that would increase the top rate for those that make $400,000 or more. It would go up to 25 percent if this measure is enacted.
Any increase is not good news for people that are in this bracket, but to put it into context, the White House has proposed a 39.6 percent rate for people that claim at least $1 million
Inheritors do not have to pay regular income taxes on inheritances for the most part, but there are a couple of exceptions. The situation is based on whether or not taxes were paid on the income that will be transferred to the beneficiaries.
Distributions of the principal in a trust would not be taxed, but the earnings were never taxed previously, so distributions of the earnings would be subject to taxation. This principle also applies to individual retirement account beneficiaries.
Roth accounts are funded after taxes were paid on the income, so there is no taxation on distributions to the beneficiary or the original account older. Traditional accounts are funded with pretax earnings, so distributions must be claimed as income.
The federal estate tax is not a factor for most people because you can transfer a rather large amount tax-free. This is called the exclusion or credit, and it is $11.7 million this year.
The House Ways and Means Committee has established a budget that would include a reduction in the exclusion to just over $6 million. This would begin at the beginning of next year, so this is an unfolding situation that we will monitor closely.
There are 12 states that have state-level estate taxes, and the District of Columbia also has an estate tax. South Carolina does not have an estate tax, but a resident of our state could face state-level estate tax exposure if they own property in one of these states.
An inheritance tax is different from an estate tax, and in fact, Maryland has an estate tax and an inheritance tax. The estate tax is levied on the entire taxable portion of an estate, but an inheritance tax can be imposed on transfers to each individual inheritor.
There are just five states that have inheritance taxes, and once again, South Carolina is not among them.
Put the Procrastination Behind You!
The vast majority of American adults do not have estate plans in place, but surveys have found that most of them know that it is an important responsibility. If you are among the unprepared, today is the day for action.
You can set up an appointment at our Bluffton, SC estate planning office if you call us at 843-815-8580, and you can use our contact form if you would like to send us a message.
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