It is logical to wonder if your heirs will be forced to pay taxes on their inheritances. Perhaps surprisingly, in large part, the answer to this question is no. Inheritances are not subject to regular income taxes, and this would include insurance proceeds.
Plus, people that inherit appreciated assets get a step-up in basis. This means that for capital gains purposes, the value of the assets that are inherited would be equal to their value at the time of the transfer. The person receiving the bequest would not be faced with capital gains exposure on the appreciation and took place during the life of the deceased individual.
However, there is a federal estate tax in place that carries a heavy 40 percent maximum rate. An estate tax is applied on the totality of the taxable value of an estate before it is transferred to the heirs. There is another type of tax called an inheritance tax that can be levied on transfers to every individual nonexempt inheritor.
Fortunately, there is no federal inheritance tax, but there are a handful of states that impose state-level inheritance taxes. We practice law in Monterey, California and there is no inheritance tax in our state. And speaking of state laws, some states have state-level estate taxes, but once again, we are fortunate in this regard because there is no state death tax in the Golden State.
Estate Tax Exclusion
The existence of the federal estate tax and its 40 percent top rate is the bad news, but the good news is that there is an estate tax credit or exclusion. This is the amount that you can transfer before the tax would kick in. At the time of this writing, the estate tax exclusion is $11.2 million, but it can be increased to account for inflation.
This death tax can be applied on transfers to anyone other than your spouse. If you are married to an American citizen, you can utilize the unlimited marital deduction to transfer any amount of property to your spouse free of the federal estate tax. Due to the relatively recent recognition of same-sex marriages that was handed down by the Supreme Court, this applies to all couples that are legally married in the eyes of the law.
The exclusion is allotted to each individual taxpayer, so a married couple would have a total of $22.4 million to pass along to loved ones before the death tax would become applicable. It is also worthwhile to note that the estate tax exclusion is portable. In this context, the term “portability” describes the ability of a surviving spouse to utilize the exclusion that was afforded to his or her deceased spouse.
It would be logical to consider lifetime gift giving as a way to avoid the estate tax. Unfortunately, there is a federal gift tax in place to prevent this practice. The $11.2 million exclusion is a unified credit that applies to large lifetime gifts coupled with the value of your estate when it is being transferred after you are gone.
We say “large” gifts because there is additional annual gift tax exclusion of $15,000 per person. You can use this exclusion to give tax-free gifts that are valued at $15,000 or less to an unlimited number of recipients each year without dipping into your available unified lifetime exclusion.
Estate Tax Efficiency Strategies
There are things that can be done to reduce your estate tax exposure if you are a high net worth individual here in California. We would be more than glad to get to know you, gain an understanding of your situation, and make appropriate recommendations. To schedule a consultation, call us right now at 831-649-1122.