We are going to look at the guidelines for capital gains taxes on an inheritor in this post. But before we focus on that subject, we will provide a general overview of taxation as it applies to your estate.
State and Federal Income Taxes
Since the taxman always wants a piece of the pie, a lot of people assume that you would have to claim an inheritance as taxable income. In fact, this is not the case, and there is a rationale behind this arrangement.
To explain through the use of a simple example, let’s say that you save 10 percent of your take-home salary for 20 years. You put it in a bank account, and you leave the bank account to your son.
The money was part of the remainder that you had left after you paid taxes on your income. If your son had to claim the inheritance as income, it would be an instance of double taxation.
This logic makes a lot of sense, but it is thrown out the window when it comes to estate taxes as we will explain in another section.
Individual Retirement Accounts
Though there are some hybrids, generally speaking, there are two different types of individual retirement accounts that are typically utilized: traditional accounts, and Roth IRAs.
If you have a traditional account, you make contributions before you pay taxes on the income. As a result, when you take distributions, they are looked upon as taxable income. This would also apply to a beneficiary of the account.
A Roth individual retirement account is funded with after-tax income, so distributions to the original account holder or a beneficiary are not subject to taxation.
Estate and Gift Taxes
There is a federal estate tax in the United States that has a 40 percent maximum rate, but it is only a factor for very high-net-worth families.
At the time of this writing in 2024, the exclusion is $13.61 million. This is the amount you can transfer before the estate tax is applied to the remainder.
There is a gift tax that is unified with the estate tax, so the $13.61 million exclusion that we have this year is a unified exclusion. It applies to large gifts along with the estate and will be transferred after you are gone.
Here in Connecticut where we practice law, there is a state-level estate tax with the same $13.61 million exclusion this year, and there is a flat 12 percent rate. Connecticut is the only state with an estate tax that also has a gift tax.
Capital Gains Tax and the Step-Up in Basis
Now we can take a look at the capital gains tax. If you inherit assets that appreciated during the life of the person who left you the inheritance, the assets would get a step-up in basis. This means that you would not be forced to pay capital gains taxes on those gains.
The capital gains tax would be a factor if you retain ownership of the assets and sell them at a later date after they have appreciated further.
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Mr. Horowitz was awarded his Juris Doctor degree with honors from the University of Connecticut School of Law. While attending law school, Mr. Horowitz received the American Jurisprudence Award in Legal Ethics and the Nathan Burkan Award.
After graduation from law school, Mr. Horowitz continued his legal education at New York University School of Law where he received a Post Doctorate Law Degree in Taxation. He has also recently received a national achievement award.
Mr. Horowitz is admitted to practice before all the state courts in the State of Connecticut and the United States District Court.
Mr. Horowitz was selected for Super Lawyers in 2021, 2022 and 2023.