Estate planning attorneys field many questions about taxes on inheritances and people usually have negative expectations. They are pleasantly surprised when they hear the facts. We will pass along the good news and a little bit of bad news in this post.
State-Level Estate Tax
A dozen states and the District of Columbia have state-level estate taxes. Oklahoma does not have an estate tax, but if you own property in a state that does, the tax will apply to your estate if its value exceeds the amount of the exclusion.
An exclusion is the amount that can be transferred before the estate tax is applied on the remainder. The lowest exclusion is $1 million in Oregon and Massachusetts and the highest is $5.93 million in New York.
In addition to these estate taxes, there are six states state-level inheritance taxes. This tax is levied on the distributions to individual inheritors when a single estate is being administered.
As an Oklahoma resident, you could be impacted by another state’s inheritance tax. Let’s say that your uncle leaves you a thoroughbred horse farm in Kentucky, which has an inheritance tax. You would be subject to taxation on this inheritance.
Income Tax and Capital Gains Tax
Besides estate and inheritance taxes, people often worry about income taxes. You may assume you have to report the amount inherited through wills or life insurance policies, but these are not subject to income tax.
If you inherit an individual retirement account (IRA), whether tax needs to be paid will depend on the type of account you inherit. Distributions from a traditional IRA account are taxable, but distributions from a Roth IRA are not.
Currently, inherited assets that have increased in value over the life of the decedent qualify for a stepped-up basis. This means that for capital gains purposes, the value of an appreciated asset would be reset when you inherit it. You would only be responsible for gains that accumulate from that point forward when and if you sell and realize a gain.
Federal Estate Tax
While we are on the subject, we should provide you a brief overview of the federal estate tax. This tax carries a 40 percent top rate, so it can take a heavy toll on your legacy.
The good news is that the federal estate tax exclusion in 2021 is $11.7 million. This amount is adjusted each year for inflation and represents a $120,000 increase over the 2020 exclusion amount.
There also is a federal gift tax to prevent people from giving away assets to avoid the estate tax. Connecticut is the only state with a gift tax.
If you are married, you can use the unlimited marital deduction to transfer whatever you choose to your spouse tax-free as long as your spouse is an American citizen. The federal estate tax exclusion is portable, so a surviving spouse can use the $11.7 million exclusion allotted to their deceased spouse if he or she passes in 2021.
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