Welcome back. The wonderful world of taxes is everyone's favorite topic. When it comes to estates and estate administration, "taxes" can take on many different meanings. Let's explore a few.
Estate Taxes
In the system we currently operate under, estates are potentially subject to a federal estate tax. Since we live in Illinois, an estate also may be subject to a state estate tax. (Many states do not have a state estate tax, but we have to fund the Chicago machine.) Any individual who passes away owning total assets that are less than $11,180,000 is currently exempt from any federal estate tax. This amount has recently increased substantially, and will affect only a small percentage of estates. The State estate tax exemption amount in Illinois is $4,000,000. These taxes, if imposed, are extremely punitive. (It is worth noting that this is a tax on money you were already taxed on during your lifetimes. Call your Congressman and tell him how ridiculous this is.)
These estate tax exemption amounts can, and do, change from time to time. Even over the last ten years, these amounts have varied drastically.
Income Taxes
When an individual dies, the Personal Representative is charged with filing income tax returns for the deceased's last year of life. Those tax returns would be filed, if necessary, just as they were filed when the decedent was living.
In addition to filing a personal income tax return, the Personal Representative is also well advised to file income tax returns for the estate each year. The estate is a separate, taxable entity, so any income earned on assets of the estate during the administration of the same will need to be accounted for. Typically, the income is passed through to the beneficiaries by this filing.
Inherited Assets and Tax Basis
With the exception of the taxes outlined above, there is no "inheritance tax" on assets inherited by a beneficiary. I supposed the government decided taxing assets 2-3 times was sufficient. An added benefit to a beneficiary of an estate is that the beneficiary gets a step-up in tax basis for inherited assets to the value at the date of death. (If that doesn't make sense, keep reading.)
The step-up in basis can be very advantageous if a beneficiary ever decides to sell an asset that has appreciated over the course of the deceased's lifetime. This is probably best illustrated with an example:
Deceased owned 40 acres of farm ground that he inherited from his father in 1953. The Deceased's tax basis in that asset would have been the value of the asset in 1953, which we will estimate to be $20,000. So, had the Deceased sold the asset in 2018 for $400,000, it would have been sold with a large gain. The Deceased would have been taxed on the difference between the sale price and the tax basis, or $380,000. If the Deceased's only son inherited the farm ground in 2018, after his father passed away, the son's tax basis in the ground is now the 2018 value, or $400,000. So, if the son sold the ground for $400,000, he would have no gain on the sale, and therefore no tax.
Next time, we will discuss finalizing the estate and how distributions are typically made.
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