It is natural to think that you may have to claim an inheritance as taxable income when you file your federal and state tax returns. In fact, in a rare instance of good news about taxation, this is not the case at all. We will look at the details in this post and provide an examination of taxation in general.
Double Taxation
You do not have to report an inheritance that you receive when you file your income taxes. This applies to direct inheritances along with insurance policy proceeds.
Why are you off the hook? To explain through the use of a very simple example, let’s say that your grandmother made a point of saving a percentage of her pay each period with the intention of passing it along to you.
In this example, your grandmother set aside the money after taxes were taken out of her salary. When you inherit the money, the taxes due will have already been paid. As a result, this is not taxable income. Additional payment of taxes would be an example of double taxation.
However, let’s say that your grandmother conveyed the money into a trust, and you are the beneficiary. The money is invested, and the principal grows. If you receive distributions of the earnings, such distributions would be taxable, because the income was not taxed.
On the other hand, if you receive distributions of the principal, they are not considered income and thus not taxable.
Traditional individual retirement accounts are funded before taxes have been paid on the income. The account holder gets an immediate tax break because they are paying taxes on less income. Distributions, however, are subject to regular income taxes. This also applies to a beneficiary.
Capital Gains Tax
When you sell appreciated assets, you are realizing a gain for capital gains tax purposes, and this tax will be applicable. In the inheritance planning realm, there is a major benefit when appreciated assets are being transferred to a beneficiary.
The assets get a stepped-up basis, which means your beneficiaries are not responsible for gains that accumulated during your life. This is income that will never be taxed. On the other hand, they would be required to pay capital gains taxes on all future gains that are realized.
Federal Estate Tax
We have a federal estate tax in the United States with a 40 percent maximum rate. You probably do not have to be concerned about it. This is because there is a credit or exclusion that gives you the ability to transfer a certain amount tax-free before the remainder would be taxed.
In 2017, the exclusion was $5.49 million. Fortunately the Tax Cuts and Jobs Act was enacted at the end of that year. It doubled the exclusion with an inflation adjustment, so it was $11.18 million in 2018. This year, it is $12.06 million.
There is a gift tax that is unified with the estate tax. It is in place to stop people from giving lifetime gifts for the purpose of avoiding taxation. The exclusion is a unified exclusion, so if you gave $12.06 million in tax-free gifts this year, there would be nothing left to apply to your estate.
On January 1, 2026, the provision in the 2017 tax measure is going to sunset, and the exclusion will go down to $5.49 million indexed for inflation. If taxation is a source of concern, you should consider gift giving while the estate tax exclusion is still at a record high level.
Some states have state-level estates taxes, but Oklahoma is not one of them.
Attend an Education Program!
You are here because you are looking for information about estate planning and nursing home asset protection, and you are making the right connection. We invite you to explore the written materials on this site, and to attend one of our education programs.
These events are offered free of charge, and you will come away with a great deal of useful knowledge if you take advantage of the opportunity. You can see the dates and obtain more information if you visit this page: Oklahoma City estate planning education programs.
Since founding Parman & Easterday in 1985, Larry has led over 1,000 free, community-service education programs and helped more than 10,000 Oklahoma families go from putting off their estate plan to getting it done. His goal for every client is the same: to become the person their family calls "the one who took care of everything."
Larry is the author of three books: The Straight Shooter's Guide to Estate Planning; Estate Planning Basics; and Guiding Those Left Behind in Oklahoma. He served as Oklahoma's Secretary of State and Secretary of Commerce, and his firm is the only member of the American Academy of Estate Planning Attorneys in the state.
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