When an estate is being transferred, the inheritors are receiving income in a sense, so people have questions about income taxes on bequests. In addition to this situation, you may have heard about estate taxes and inheritance taxes.
All this can get pretty confusing, and in this post, we will provide the facts so you can go forward with a renewed understanding of taxes on inheritances.
Income Tax and Capital Gains Tax
The assets that comprise your estate are left over after you paid taxes throughout your life. For example, if you put $100 out of every paycheck into an account that you are going to leave to your grandchildren, this would be coming out of your net income after you paid taxes.
If your grandchildren had to report their inheritances as taxable income, it would be two different rounds of taxation on the same income, and that would not be fair. As a result, direct bequests are not subject to regular income taxes.
This logic goes out the window if you can save considerably more than $100 out of every paycheck, but this is a matter that we will address in the next section.
The beneficiary of a living trust would not have to report distributions of the principal, but distributions of the earnings would be taxable.
With regard to inherited individual retirement accounts, you contribute into a traditional account before you pay taxes on the income, and Roth accounts are funded with after-tax income.
As a result, distributions from a Roth account are tax-free, and traditional account distributions are taxable. This arrangement also applies to the beneficiaries of individual retirement accounts when they take distributions.
If you inherit assets that appreciated during the life of the person that left you the inheritance, they would get a stepped-up basis. This means that you would not have to pay the capital gains tax on the gains that accumulated when the decedent was the owner of the assets.
Federal Estate Tax
There is a federal estate tax that carries a 40 percent maximum rate, so it can take a big bite out of your legacy. Even though it is an instance of double taxation, it is a fact of life.
The good news is that most people don’t have to pay the tax, because there is an $11.7 million exclusion. You can transfer this much tax-free before the estate tax would be levied on the remainder.
If you are married, you can use the unlimited marital deduction to transfer any amount of property to your spouse tax-free. The exclusion is portable between spouses, so a surviving spouse can use the exclusion that was earmarked for their deceased spouse.
New York State Estate Tax
New York is one of 12 states in the union with a state-level estate tax, so you could be forced to pay both taxes if you are quite wealthy. The New York exclusion is the highest among the states with estate taxes at $5.93 million.
There is also a strange provision that is unique to New York. If the value of your estate is at least 105 percent of the exclusion amount, the entirety of your estate would be subject to the estate tax.
There is no gift tax in our state (Connecticut is the only state with a state-level gift tax), but there is a three year clawback provision. Large gifts that you give within three years of your passing are considered to be part of your estate for tax purposes.
Inheritance Taxes
As we have stated, an estate tax is levied on the taxable portion of an estate before it is transferred to the heirs, so there is just one instance of taxation. An inheritance tax can be imposed on transfers to each individual inheritor that is not exempt.
There is no federal inheritance tax, and there are six states that have state-level inheritance taxes. Fortunately for us, New York is not one of them.
However, the states with inheritance taxes include our neighbors in New York and Pennsylvania along with Maryland, Kentucky, Nebraska, and Iowa. If you inherit property that is located in any of these states, their inheritance tax would apply to you.
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While he was in law school, he worked as an aide to the late John Sparkman, Senior Senator from Alabama. This gave him the opportunity to gain intimate knowledge of the workings of government, and this background has served him well.
He started his private practice in New York in 1974, the first Sikh to be admitted to the bar in the state of New York.And in 1995, when he narrowed his legal focus to the areas of estate planning and elder law, the prestigious American Academy of Estate Planning Attorneys accepted him into their membership.
Special needs planning is an important aspect of the field, and Mr. Khalsa has intertwined his empathy with his expertise to become a leading advocate in this area. Shortly after the Education for All Handicapped Children Act was enacted in 1975, he won the first case in New York that was adjudicated under this law.
S.J. Khalsa has a penchant for philanthropy, and he has raised well over $20 million for charities nationwide. He is a deeply spiritual man who represents the Sikh religion at religious and interfaith gatherings all over the globe.
He believes that successful professionals should contribute to the fabric of their communities, and to this end, he works with law enforcement in New York.
Mr. Khalsa is a graduate of the FBI Citizens Academy program, and he is active in their Alumni Association. He is a member of the FBI/New York Police Department Joint Task Forces on Civil Rights and Hate Crimes, and he sits on the Community Engagement Council that advises the FBI Assistant Director for New York.
He is the author of the highly acclaimed book, Estate Planning Essentials: A Guidebook for Modern Families. Lawyers of Distinction recognized him for his excellence in 2020, naming him a 2020 Power Lawyer, and he is a member of the prestigious American Academy of Estate Planning Attorneys.
Mr. Khalsa lives in Manhattan with his wife, and he has two grown children and four grandchildren. He likes to travel, and he is an avid golfer. As the co-owner of Kundalini Yoga East in New York along with his wife, he instructs practitioners and aspiring yoga teachers.
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