This column first appeared in the San Antonio Express News on October 27, 2015.
Dear Mr. Premack
Historically, Congress has maintained several different tax classifications (all found in the Internal Revenue Code and administered by the IRS). For instance, the income tax is very different from the gift tax or the estate tax or excise taxes (like the taxes we pay on gasoline, alcohol or cell phones).
When you are due an inheritance, it may be subject to two taxes before you receive it: estate tax and inheritance tax. Estate tax is imposed by the federal government, is paid by the estate’s Executor from the estate, and is due only if the value of the estate exceeds $5.43 million. Inheritance tax is imposed by the state government, and it varies from state-to-state. Texas no longer has an Inheritance tax, and California eliminated its Inheritance tax in 2005.
Since your $40,000 inheritance comes to you after payment of any Estate and Inheritance taxes, you get to keep the entire $40,000. But when you receive it, must you declare the $40,000 on your 1040 Income tax return? No. An inheritance is not earned or produced by an asset you own, so it is not considered to be taxable income. Do not report the inheritance on your 1040.
Once the money is in your bank account, the bank may pay you interest on the deposit. That interest earned is taxable income, and must be reported by you on your 1040. It is new money that is produced by an asset which you own, and has no further relationship to the inheritance.
Here’s another tax issue to consider. Assume you inherited shares of stock instead of cash. Generally, when a person sells stock (or any appreciated asset) the profit is subject to capital gains tax. For instance, if you buy 1000 shares of stock for $40 each (investing $40,000) and one year later you sell those shares for $42 each ($42,000) then you have a $2000 taxable gain.
What if your aunt had purchased those same shares and left then to you upon her death? If you decide to sell the shares, how are you taxed? She bought them for $40,000. They were worth $42,000 when she died. You later sell them for $43,000. Will you be taxed on $3000 (the difference between her purchase price of $40,000 and the sales price of $43,000) or will you be taxed on $1000 (the difference between the date of death value of $42,000 and the sales price of $43,000)? You get to calculate the capital gain tax by using the date of her death value instead of the purchase date value, so your taxable gain is $1000.
Dear Mr. Premack: My mother signed an enhanced life estate deed aka ladybird deed over to me and it was recorded in the county clerk’s office. Who should the owner name be on appraisal records? Will she still get her homestead and over 65 property tax exemptions? Will Medicaid ask for a copy of the tax statement?
Your mother still owns the life estate. The appraisal district should list her has the owner with the notation “L/E” next to her name. They should not list your name, since you have no rights until your mother has died (assuming she does not exercise her right to revoke the ladybird deed). Consequently, she retains her homestead exemption, her 65+ exemption and her school tax freeze. When she dies and you become owner, those exemptions end and taxes for you will be quite a bit higher. Medicaid may ask for a copy to establish that the money she spent to pay the taxes was legitimate and for her benefit.
Paul Premack is a Certified Elder Law Attorney with offices in San Antonio and Seattle, handling Wills and Trusts, Probate, and Business Entity issues. View past legal columns or submit free questions on legal issues via www.TexasEstateandProbate.com or www.Premack.com.