Many people have concerns about taxes on the inheritance they may leave to their loved ones. For the most part, the news about taxation is surprisingly good.
Generally speaking, inheritances are not subject to regular income taxes. If you inherit assets that appreciated in value while they were held by the person who left you the inheritance, they will get a step-up in basis. This means that you would not pay any capital gains tax on that appreciation.
On the downside of the equation, there is a federal estate tax, but there is a good chance that you and your family will not need to be concerned about it. Let’s look at the details.
Federal Estate Tax Exclusion
There is a federal estate tax credit or exclusion that is a set amount that can be transferred tax-free after death. The portion of an estate that exceeds the exclusion would potentially be subject to this federal estate tax, which carries a 40 percent maximum rate. In 2024, the federal estate tax exclusion is $13.61 million.
Federal Gift Tax
Lifetime gift giving would naturally come to mind as a way to avoid the estate tax. People would make lifetime gifts to avoid taxes after the estate tax was enacted in 1916. In 1924, a gift tax was put into place to close this loophole. It was repealed in 1926, but the gift tax was reenacted in 1932.
We have had a gift tax ever since. The estate tax and the gift tax were unified under the tax code in 1977. As a result of this unification, the exclusion is a unified exclusion that encompasses lifetime gifts and your estate.
However, there is an additional annual gift tax inclusion. You can give up to $18,000 each to an unlimited number of people each year tax-free without cutting into your unified exclusion.
There is also an educational exemption, so you can pay school tuition for students without being concerned about a gift tax. The same arrangement applies to the payment of medical bills and healthcare insurance for someone else.
Spousal Considerations
There is also an unlimited marital deduction. You can transfer any amount of property to your spouse without incurring any transfer tax liability with one caveat. This marital deduction is only available to citizens of the United States, so you cannot use it if your spouse is not a U.S. citizen.
This is less than ideal, but fortunately, there is an estate planning solution for married couples who cannot use the unlimited marital deduction. We will explain the details in a future blog post.
The estate tax exclusion has been portable since 2011. This means that a surviving spouse could use the exclusion that was earmarked for their deceased spouse.
State-Level Estate Taxes
In addition to the federal estate tax, state-level estate taxes may enter the picture as well. Our estate planning office is in Chico, California, and there is no California state estate tax.
There are 12 states that have state-level estate taxes, including Oregon, Washington, and Hawaii. If you own property in one of these states, the tax in that state would apply to your estate if the value of the property exceeded the exclusion in that state.
State-level exclusions are usually considerably lower than the federal exclusion. For instance, the exclusion in Oregon is just $1 million, so this is another consideration if you have out-of-state property.
Pending Estate Tax Exclusion Reduction
The $13.61 million exclusion that we have this year is the highest ever. It came about via a provision in the Tax Cuts and Jobs Act that was enacted at the end of 2017.
During that calendar year, the exclusion was $5.49 million. It had been $5 million indexed for inflation annually since 2011. The 2017 tax cuts essentially doubled the exclusion with an inflation adjustment for 2018.
The provision in this measure that raised the estate tax exclusion is going to expire at the end of 2025. On New Year’s Day in 2026, the exclusion will go back to the 2017 level of $5.49 million indexed for inflation.
This will expand the number of people that need to be concerned about the federal estate tax. Since property values are so high here in California, this reduction is particularly relevant to many residents of the Golden State.
Estate Tax Efficiency Strategies
There are things that you can do to mitigate the damage if estate taxes are a source of concern. Plus, you have a limited window of opportunity between now and 2026. You can use the expanded exclusion to fund certain types of tax efficiency trusts, and we can show you how.
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To see the dates and obtain more information, visit our workshop schedule page.
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