People are sometimes confused about the way that taxes can impact inheritances. Most folks have heard of the terms “inheritance tax and “estate tax,” and many harbor some misconceptions about them.
The first one is the assumption that these are two ways of describing the same tax. This makes total sense on the surface, but in fact, they are two different forms of taxation.
An estate tax would be applied to the total taxable portion of an estate before it is transferred to the heirs. On the other hand, an inheritance tax could be imposed on transfers to each individual inheritor.
There is a federal estate tax, but very few people have to pay it because there is a rather high exclusion. This credit or exclusion allows you to pass along a certain amount tax-free before the rest would be taxable. In 2023, the exclusion is $12.92 million.
There is no estate tax on transfers between spouses because there is an unlimited marital deduction. However, to use it, you and your spouse must be American citizens. The estate tax exclusion is portable, so a surviving spouse can use their deceased spouse’s exclusion.
Federal Gift Tax
You cannot give gifts while you are living to completely avoid the estate tax because there is a gift tax that is unified with the estate tax. The multimillion-dollar exclusion applies to large lifetime gifts along with your estate.
There is an additional annual exclusion that you can use to give up to $17,000 to an unlimited number of gift recipients each year without using any of your unified exclusion.
State-Level Estate Taxes
There are some states in the union that have state-level estate taxes. We practice in the great state of Oklahoma, and there is no estate tax in our state. That’s the good news, but there is a way these taxes can potentially affect you.
If you own property in a state that has an estate tax and its value exceeds the exclusion in that state, it will apply to your estate. It should be noted that the exclusions in states with estate taxes are typically much lower than the federal exclusion.
There is no federal inheritance tax, but there are six states that have state-level inheritance taxes. Once again, Oklahoma is not on this dubious list, but this type of tax could be a factor if you inherit property that is located in a state with an inheritance tax.
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