Is an estate tax another way of referring to an income tax on an inheritance?
Actually, you do not have to report an inheritance as taxable income to the state or the IRS. Another positive is the fact that you do not have to pay capital gains taxes on inherited assets that appreciated during the life of the person that left you the resources.
If that’s the case, what is the federal estate tax all about?
There is an estate tax on the federal level, and it can significantly impact your legacy because it carries a 40 percent maximum rate. That’s the bad news, but the good news is that most people don’t pay the tax. You can use the estate tax exclusion or credit to transfer a certain amount tax-free before the tax would be imposed on the remainder. The amount of the exclusion was changed after a tax act was passed at the end of 2017, and it became a reality the following year. At that time, the exclusion was $11.18 million, and there have been relatively modest annual adjustments since then to account for inflation. This is the way it will stand unless the exclusions change via legislative mandate at some point in the future.
So your spouse has to pay an estate tax if you leave them a large estate?
That is the one exception to the rule. There is an unlimited marital deduction that allows you to leave any amount of property to your spouse free of the estate tax. However, to use this deduction, your spouse must be an American citizen. Speaking of spouses, can a surviving spouse use their deceased spouse’s exclusion? In an estate planning context, this is the question of portability, and the answer is yes. Since 2011, the estate tax exclusion has been portable.
Can you give gifts to avoid the estate tax?
The estate tax was originally enacted in 1916, and this was possible at first. In 1924, the gift tax was enacted, but it was repealed two years later. The gift tax was reenacted in 1932, and it has been in place ever since then. This tax is unified with the estate tax, so the exclusion is a unified exclusion that applies to large lifetime gifts coupled with the estate that will be transferred after your passing.
Is there any other related tax that I should be concerned about?
There are a number of states in the union that have state-level estate taxes. We practice in New York, and there is an estate tax in our state. The exclusion is approximately half of the federal exclusion, so you can be exposed on the state level even if you are exempt from the other tax. In New York, the rate that you pay depends on the amount that will be transferred. It starts at 3.06 percent, and it maxes out at 16 percent.
What about gift giving on the state level?
There is no New York state gift tax, but there is a three-year claw-back provision. If you give large gifts within three years of your death, the value of the gifts would be added to your estate for tax purposes.
Is there anything else I should know?
Yes, there is a unique phenomenon in our state called the estate tax exclusion “cliff.” If the value of your estate is more than 5 percent above the exclusion amount, you would not be able to use any exclusion. The entirety of your estate would be subject to taxation.