When you are planning your estate, you should understand the tax situation and share the information with your loved ones, so they know what to expect. We are going to look at the capital gains tax first, and we will finish with an explanation of the other taxes that can enter the picture.
Step-Up in Basis
If you inherit appreciated assets, do you pay taxes on the gains that accumulated while the decedent was alive? The answer is no because the assets would get a stepped-up basis.
Let’s say that you inherit $200,000 worth of stock from your grandfather, and he paid $100,000 for the shares when he purchased them. When he was alive, the basis for tax purposes was $100,000, so the $100,000 gain would have been taxable if he realized the gain.
Since he never sold the stock while he was living, he did not realize a gain, so he never paid the capital gains tax. When you inherit the assets, they get a stepped-up basis, so you get a reset with a $200,000 basis going forward. You would not owe anything at the time of acquisition.
With regard to the rate, there are short-term gains and long-term gains, and the dividing line is one year of possession of the assets after acquisition. Short-term gains are taxed at your regular income tax rate, and long-term rates are based on income.
People that earn $41,675 or less are not required to pay capital gains taxes on long-term gains. The rate is 15 percent for filers that make more than this amount but less than $459,750. For those that claim more than $459,750, the rate is 20 percent.
There are no income taxes on inheritances when the assets that are being transferred are after-tax resources. If taxes have not been paid by the decedent, the inheritor would be required to report the income.
As a result, distributions from the earnings in a trust would be taxable, but the principal could be transferred tax-free.
There are no taxes on distributions to a Roth individual retirement account beneficiary because the original account holder funded the account with after-tax earnings. Deposits into traditional accounts are made before taxes are paid, so distributions are taxable.
The federal estate tax is applicable on the portion of an estate that exceeds the credit or exclusion, which is $12.06 million this year. It is going down to $5.49 million indexed for inflation when a provision in the Tax Cuts and Jobs Act expires.
There are 12 states with state-level estate taxes, but California is not one of them. However, if you own valuable property in a state with an estate tax, it would apply to your estate if its value exceeded the exclusion in that state.
State-level exclusions are lower than the federal exclusion. For example, the exclusion in Oregon is just $1 million, and this is also the exclusion in Massachusetts.
There are state-level inheritance taxes in Iowa, New Jersey, Pennsylvania, Maryland, Kentucky, and Nebraska. This is a tax on distributions to individual inheritors rather than the entire taxable portion. The Iowa tax has been repealed, but it will be phased out over a few years.
We are sharing this information because a California resident could be required to pay a state-level inheritance tax if they inherit property that is located in one of these states.
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We can help you mitigate the damage if taxation is a source of concern, and legal counsel is equally important if your estate will be exempt. Each situation is different, so you should understand your options and make informed decisions to provide for your loved ones in the optimal manner.
If you are ready to schedule a consultation appointment at our Burbank, CA estate planning office, you can call us at 818-937-2335, and you can use our contact form to send us a message.