People often have questions about inheritances and taxation, and they are usually pleasantly surprised when they hear the answers. First, heirs who receive bequests do not have to report them as taxable income, so that can seem like a break, but it is only fair.
This is because an estate is comprised of property that was retained after the decedent paid taxes throughout his or her life.
Another positive from a tax perspective is the step-up in basis for appreciated assets. If you inherit resources that appreciated during the life of the decedent, you would not have to pay capital gains taxes on the appreciation.
A tax that can enter the picture after someone dies is the federal estate tax. Though this could be viewed as an instance of double taxation given the fact that the person who passed away already paid taxes, it is a fact of life.
Most families do not have to be concerned about the federal estate tax, because it is only applied on the portion of an estate that exceeds the credit or exclusion. At the time of this writing in 2020, the figure is $11.58 million. There are annual adjustments to account for inflation, so you may see a somewhat higher number next year.
It should be noted that the estate tax is typically not imposed on transfers to people who are married to one another, and the exclusion is portable. This means that a surviving spouse can use the exclusion that was allotted to his or her deceased spouse.
If you are exposed to the federal estate tax, lifetime gift giving would come to mind as a way to get around it. This loophole existed in 1916 when the estate tax was enacted, but a gift tax was installed in 1924 to close it. The tax was repealed in 1926, but it returned permanently in 1932.
During the decade of the 1970s, it was unified with the estate tax, so the exclusion is a unified lifetime exclusion that applies to gifts and the estate that will be transferred after you are gone.
This being stated, there are some other gift tax exemptions that can be used that sit apart from the $11.58 million unified exclusion. One of them allows you to give as much as $15,000 to an unlimited number of gift recipients annually free of taxation.
People who are exposed to the estate tax can use this annual exclusion in various ways to gain estate tax efficiency. For example, let’s say that you have three married children, and you are married yourself.
You and your spouse could combine your respective exclusions and give $30,000 tax-free to each husband and each wife. That would equate to $180,000 annually, and this could add up considerably over an extended period of time.
This exclusion can be utilized to fund certain types of trusts tax-free, and it can be useful when assets are changing hands among partners in a family limited partnership.
Another gift tax exclusion is the educational exemption. Under Internal Revenue Service rules, you can pay school tuition for students free of transfer taxes. The payments must be made directly to the institutions, and the exclusion does not extend to fees, books, and living expenses.
Of course, if you want to provide additional support, you could use your $15,000 per year, per person exclusion to do so in a tax-free manner.
The final exemption applies to the payment of medical bills for other people, and this would include health insurance premiums.
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