Last week the market set several new highs before declining slightly on Friday. The Federal Reserve held interest rates steady, but indicated they believe inflation is slowly coming down. The Fed is projecting one rate cut later this year. While the economy has proved resilient so far, we are beginning to see softening in the labor market. At the same time, over one-third of the S&P 500’s returns this year has been from just one stock.1 Which means that if you are in a traditional S&P 500 index fund, your holdings are becoming more concentrated, and more subject to individual company risk, rather than overall market risk.
Continuing our discussion of inheritances, there are two types of tax, outside of pre-tax money in a retirement account or annuity. There is estate tax and inheritance tax. Estate tax is applied at both the federal and state level. While the current rules sunset at the end of 2025, you can currently pass over thirteen and a half million dollars to your heirs – and double that for a married couple – without any federal estate tax. In Maryland, you can leave five million dollars to your heirs, or ten million dollars for a married couple, without any state-level estate tax. If you are fortunate enough to be over those limits, Maryland will tax the excess between 8 and 16%. At the federal level, it’s between 18 and 40%. If you’re at those upper levels, it is worth working with an estate attorney to establish trusts and minimize a potential 56% tax bill.
There is also an inheritance tax, which is a state-only tax. There are only six states that have an inheritance tax, and Maryland is the only state with both inheritance and estate taxes. The Maryland tax applies to any money left to someone outside of your immediate family: nieces or nephews, cousins, or friends. Ten percent of those funds will go to the state.
The good news is that the personal representative, or what used to be called the executor of the estate, handles all of the tax issues. Most estate plans call for the estate to pay any taxes due before funds are distributed to heirs. If you’re the personal representative, we highly recommend you consult with a qualified estate attorney.
If you receive an inheritance outside of retirement accounts, like property or an investment account, you inherit those with a stepped-up basis. Your tax basis, or cost basis, is what was paid for the item – real estate, stocks, bonds. When something is gifted to you, your basis is the same as the person who originally bought it. If you inherit it, your basis is the value as of the day that person passed away.
For example, your grandmother bought Spacely Sprockets stock in 1962 for two dollars a share and gave it to you for your college graduation. If you sell it today for $202 a share, you will pay taxes on the gain of $200. She also bought Cogswell Cogs stock for two dollars a share in 1962, and when she died it was worth $202 a share. If you inherited the stock and sold it, you have no taxable gain, as you inherited it with a cost basis of $202 a share.
For the most part, an inheritance is not a large tax liability. It’s always best to work with qualified professionals to get specific advice for your particular circumstances.
Your action item is to talk with your family about estate plans. Talk to your parents and/or your children. Wealth is often built, or squandered, over generations. Working together as a family can leave a lasting legacy.
Be sure to check out our website at covingtonalsina.com, or our Facebook page, for more information and to register for our upcoming educational events.
CovingtonAlsina is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.