People often come away a bit confused when they hear bits and pieces about the taxes that can be applied on inheritances. The term “estate tax” is commonly utilized, and you may have also heard of an “inheritance tax.”
Some people think that estate tax is a term that is used to describe the income taxes that you have to pay if you receive an inheritance. In fact, inheritances are not subject to regular income taxes. An estate tax is entirely different.
Federal Estate Tax
We do have a federal estate tax, but the vast majority of Americans can never have to pay it, because there is a high credit or exclusion. You can use this exclusion to transfer a certain amount before the estate tax would kick in. In 2020 the amount of this exclusion is $11.58 million.
Clearly, there are very few people that are in this financial stratosphere, but those that are there are looking at some significant legacy erosion. The top rate of the federal estate tax is an eye catching 40 percent.
There is no estate tax on transfers to a spouse that is an American citizen, and a surviving spouse would have two exclusions to apply to their estate. You can’t give large gifts to avoid the tax, because there is a gift tax that is unified with the estate tax.
State-Level Estate Taxes
Most states do not have state-level estate taxes, but here in Vermont where we practice law, there is a state estate tax. You could be exposed to this tax even if your estate is valued below the federal exclusion amount, because the Vermont exclusion is just $4.25 million.
We touched upon the fact that a surviving spouse could use the federal estate tax exclusion that was allotted to their deceased spouse. This is called “portability” in legal and tax vernacular.
The state-level exclusion is not portable between spouses. However, you can transfer any amount of property to your spouse free of this tax.
When it comes to transfers to others, there is no gift tax in Vermont, so lifetime gift giving is an option. For your information, the only state that does have a gift tax is Connecticut.
Inheritance Tax
Now that we have filled you in with regard to the other types of taxes on bequest, we can look at the inheritance tax and how it differs from an estate tax. As we have stated, an estate tax is applied on the taxable portion of an estate before it is transferred to the heirs.
An inheritance tax can be levied on transfers to multiple different heirs when the same estate is being administered. There is no federal estate tax, and there are just six states with state-level inheritance taxes. Fortunately, Vermont is not one of them.
The states with inheritance taxes are New Jersey, Kentucky, Iowa, Nebraska, Pennsylvania, and Maryland. If you inherit property that is located in one of the states, the inheritance tax in that state would be a factor unless you are exempt.
We added the exemption caveat because close relatives like children, parents, grandchildren, and siblings are typically exempt from inheritance taxes.
Need Help Now?
Our doors are open if you are ready to put an estate plan in place. Every situation is different, and there is no one universal way to proceed. We will gain an understanding of your unique situation, make recommendations, and help you craft the ideal plan for you and your family.
You can send us a message to request a consultation appointment, and we can be reached by phone in Essex Junction, Vermont at 802-879-7133.
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