The news about taxes on inheritances is surprisingly positive for the most part. An inheritance is not considered to be taxable income, and appreciated assets get a stepped-up basis when they are inherited. This means that the inheritor is not responsible for capital gains taxes.
On the bad news side of the coin, there is a federal estate tax. It can take a major bite out of your legacy because it carries a 40 percent top rate.
Fortunately, most people do not have to be concerned about it, but the net will be broadened in a couple of years. Let’s look at the details.
Federal Estate Tax Exclusion
The federal estate tax credit or exclusion is a set dollar amount that can be transferred tax-free. A portion of an estate that exceeds this exclusion is potentially subject to taxation.
In 2011, a $5 million exclusion was established via legislative mandate. That figure continued to hold sway with inflation adjustments through 2017. At the end of that year, the Tax Cuts and Jobs Act was passed by Congress and signed into law.
Among other things, it doubled the estate tax exclusion with an inflation adjustment for the following year. In 2018, the exclusion was $11.18 million.
After being indexed for inflation annually, the exclusion now sits at $13.61 million.
Marital Considerations
There is an unlimited marital deduction. You can transfer any amount of property to your spouse tax-free as long as your spouse is an American citizen. The exclusion is portable between spouses, so a surviving spouse could use the exclusion that was earmarked for their deceased spouse.
Federal Gift Tax
Lifetime gift-giving would be a logical reaction to the estate tax. This was done after the estate tax was enacted in 1916, but a gift tax was installed in 1924. It was repealed in 1926, but it was reenacted in 1932, and we have had a gift tax since then without interruption.
In 1977, the gift tax and the estate tax were unified under the tax code. As a result, the $13.61 million exclusion we have this year is a unified exclusion. It applies to large lifetime gifts and your estate.
We use the qualifier “large” because there is an additional annual gift tax exclusion. You can give up to $18,000 to any number of people each year tax-free without using any of your unified exclusion.
Sunset of Tax Cuts and Jobs Act
The provision in the Tax Cuts and Jobs Act that increased the exclusion will sunset on New Year’s Day in 2026. At that time, the exclusion will revert back to the 2017 level of $5.49 million indexed for inflation.
When you digest all the background information about the transfer taxes, you can see that a window of opportunity exists. You could potentially use the large exclusion to give significant gifts between now and the beginning of 2026.
To take advantage of this opening, you do not necessarily have to give direct gifts all at once. You could use the exclusion to fund certain types of tax efficiency trusts that would ultimately facilitate transfers at tax discounts.
Schedule a Consultation Today!
We can definitely help if you have tax concerns, but that’s not the only reason to work with an attorney to put a plan in place. There is no one-size-fits-all plan that is right for everyone. When you choose our firm, we will make sure that your plan is tailor-made to suit your needs.
You can set the wheels in motion by calling our Petaluma, CA estate planning office at 707-769-9975. If you would rather send us a message, fill out our contact form and we will get back in touch with you promptly.
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