Many people are pleasantly surprised when they learn that, for the most part, inheritances are not subject to taxation. You do not have to claim an inheritance on your personal income tax return, and if you inherit appreciated assets, you get a step up in basis. This means that you do not have to pay capital gains taxes on gains that accumulated during the life of the decedent.
That’s the bright side, but in addition to income taxes, there are other forms of taxation that can enter the picture when an estate is being administered. We have a federal estate tax, and it carries a very hefty 40 percent maximum rate. The majority of American families do not have to worry about it, because there is a relatively large credit or exclusion.
The estate tax exclusion is the amount that you can transfer tax-free before the estate tax would be applied. In 2011, a piece of tax legislation set the exclusion at $5 million. This benchmark was retained through 2017, but there were annual adjustments to account for inflation along the way. During that year, the exclusion was $5.49 million.
A new tax law was enacted in 2017 that changed the amount of the exclusion for the better. It was raised to $11.18 million in 2018. This is the base figure going forward, but an adjustment has been added for this year. At the present time, the estate tax exclusion stands at $11.4 million.
We should point out the fact that there is an unlimited marital deduction that allows you to leave any amount of money and/or property to your spouse free of taxation. This is true as long as your spouse is a citizen of the United States. Plus, the estate tax exclusion is portable. After the death of a married person, the survivor would have two exclusions to utilize.
You cannot give large gifts to your loved ones to avoid the estate tax, because there is also a gift tax in our country. It is unified with the estate tax, so the $11.4 million exclusion applies to large gifts that you give while you are living along with the estate that will be transferred after you are gone.
We say “large” gifts because there is another gift tax exclusion that sits apart from the unified gift and estate tax exclusion. There is an annual gift tax exclusion that allows you to give up to $15,000 to any number of people in a calendar year free of taxation. In addition to this exemption, there is another one that applies to the payment of school tuition and medical bills for others.
New York State Estate Tax
There are a number of states in the union that impose state level estate taxes. Our office is in Albany, and there is state level estate tax in New York. The exclusion is much lower than the federal exclusion, so you could face exposure on the state level even if you are exempt on the federal level.
In 2018, the New York exclusion was $5.2 million, but it has gone up to $5.74 million in 2019. You can expect more of the same next year, but the figure will be subject to an inflation adjustment. The top rate of the tax is 16 percent.
Unfortunately, New York takes a different approach when it comes the estate tax exclusion. To provide an example, if you are transferring $20 million, the federal estate tax would only be imposed on the amount that exceeds the exclusion. As a result, using the exclusion that is in place this year, the taxable amount would be $8.6 million.
Things are entirely different in New York. If the value of an estate exceeds the exclusion amount by more than 5 percent, the entirety estate would be taxed. This is referred to as the New York estate tax “cliff.”
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