The matter of taxation is something that is naturally going to come to mind when you are planning your estate. There are various different taxes that can enter the picture, but we will focus on capital gains taxation in this post.
Taxes on Gains
When you purchase assets that can appreciate, the gains are potentially taxable. For tax purposes, the gains are divided into two categories: long-term capital gains, and short-term capital gains. These two types of gains are taxed at different rates.
A capital gain is realized when you actually sell the appreciated assets and assume personal possession of the gains. The gains would not be taxable until and unless they are realized.
A short-term capital gain is a gain that is realized within five years of the original purchase of the asset in question. These gains are taxed at your regular income tax rate.
Long-term capital gains are gains that are realized at least a year after the original purchase. The government would like investors to hold on to their investments for a longer period of time. There is an incentive, because long-term capital gains are taxed at a lower rate.
People in the very top income bracket are subject to a 20 percent capital gains tax rate. This is the maximum rate. In 2014, the threshold for the maximum capital gains bracket is $406,750 for a filer who is single. A married couple would be in the maximum capital gains bracket if the combined income was $457,600 or more.
Single individuals with an adjusted income of $200,000 or more are subject to a 3.8 percent Medicare surtax. So, people who are in the maximum bracket would essentially be paying a 23.8 long-term percent capital gains rate.
The majority of people in the United States would pay a 15 percent long-term capital gains rate. People who are in the 10 percent to 15 percent income tax bracket are exempt from long-term capital gains taxation.
In states that have state-level income taxes, there is a state-level capital gains tax that is applicable. The ordinary state income tax rate is typically applied to capital gains on the state level.
Step-Up in Basis
Now that we have explained some things about capital gains taxes, we can look at the estate planning implications. If you inherit assets that have appreciated, you will not face capital gains taxation at first, because you get a step-up in basis.
Let’s say that you inherit stock that was purchased by your aunt at $50 per share 10 years before her death. When you inherit it, it is worth $100 per share. You get a step-up in basis, so the value of the shares for capital gains purposes is $100 per share when you acquire the shares.
However, if the assets continue to appreciate, you would be responsible for that appreciation.
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