New York State (USA) here with a Last Will & Testament question.
Are things like life insurance and non-probate gifts taxed? Or do they pass to beneficiaries untaxed?
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State And Federal Estate Taxes
Certain taxes are due because someone dies, which are somewhat pejoratively called "death taxes".
Inheritances taxes are imposed on the value of inheritances received by someone and neither New York State nor the federal government have inheritance taxes at this time.
Estate taxes are taxes imposed on the value of what someone who died owned immediate prior to their death and are collected with the cooperation of the executor of the person who died.
As summarized here as of February 18, 2022 (the dollar amounts are indexed for inflation):
New York is one of 12 states, along with the District of Columbia, that tax the estates of decedents who were residents or who owned property located within its borders. Aside from this, there are many other factors that go into how the state handles inheritances, beginning with whether or not you have a valid will. If you’re looking for professional guidance on navigating nuanced estate planning laws or New York inheritance laws, SmartAsset’s free matching tool can pair you with up to three financial advisors who serve your area.
While New York doesn’t charge an inheritance tax, it does include an estate tax in its laws. The state has set a $6.11 million estate tax exemption, meaning if the decedent’s estate exceeds that amount, the estate is required to file a New York estate tax return. The state government requires that these be filed within nine months of the deceased’s death, though extensions are available. The highest tax rate you could possibly pay is 16%.
It’s necessary to file a New York estate tax return if the estate’s total value exceeds the exemption listed above, according to New York inheritance laws. But for those who simply own property in New York but aren’t residents, only the value of their property in New York is included in this law. SmartAsset has further detailed the estate laws of New York if you’re looking for more information.
Other Necessary Tax Filings The New York estate tax is in addition to the federal estate tax, which calls for individual estates worth more than $12.06 million ($24.12 million for couples) between gross assets and prior taxable gifts to pay within nine months of the individual’s death. Only the value of the estate greater than the above exemption is eligible for the federal estate tax. An automatic six-month extension will be automatically granted for this should you ask for it prior to the due date.
For both federal estate tax and New York State estate tax purposes, the estate of someone who dies includes assets that they owned immediately prior to death that passed via a non-probate transfer such as a beneficiary designation or joint property ownership with right of survivorship.
Sometimes estate taxes are imposed at an enhanced rate to reflect what is called the "generation skipping transfer tax" which is imposed upon certain gifts made to someone who is in a grandchild's or more remote generation, in addition to the regular estate tax.
In the case of life insurance, the amount included in the probate estate is the face value of the life insurance benefit.
But assets that were transferred to certain irrevocable trusts prior to the death of someone who dies, are not included in their estate at death for federal or state estate tax purposes. Instead, the value of the asset at the time it was transferred to an irrevocable trust (which has to be reported on a gift tax return) is counted against that person's lifetime gift and estate tax exclusion set forth above.
An estate tax return is arguably the most difficult to complete of all tax returns in the United States and would often run to hundreds of pages of paper. The value of every asset included in the estate must be supported by ample documentation on the return (which at the federal level is on Form 706). It typically takes tens of thousands of dollars to hundreds of thousands of dollars paid to specialist CPAs, tax lawyers, and appraisers to prepare an estate tax return if the value of the estate is close to the cutoff amount.
Of course, the vast majority of estates are so small that nothing has to be filed.
In New York State there are probate court fees based in part on the state of the estate, but they are not paid by people who receive non-probate transfers (including transfers via a lifetime trust of the person who died rather than via a will).
Attorneys for the executor in New York State also also typically paid on a schedule of fees based upon the value of the assets in the estate. But again, this typically does not include assets passing in non-probate transfers.
The Poor Man's Estate Tax
Many people with working class or middle class assets and incomes have some or all of their nursing home care in their final months or years of life paid for by the Medicaid nursing home program.
The funds provided under this program are basically a guaranteed loan even though they are called means-tested welfare benefits.
If the person receiving these benefits has assets at death, the state can make a claim against those assets to recover the amounts paid by Medicaid for the person who died. This is called the Medicaid Estate Recovery Program.
Part of the program involves making claims in a probate estate handled by the executor, but another part of the program involves putting liens on property owned by the Medicaid beneficiary before they die that must be paid out of the liened property by the persons who receive it after the Medicaid beneficiary dies.
While strictly speaking this is more of a debt than a tax, it feels very much like a death tax as it is applied.
Income Taxes Of The Decedent
Final Tax Returns
The same source continues by noting that a final income tax return or returns must be filed for the person who died:
The federal and New York state governments also require a final individual state and a final individual federal income tax return to be filed by tax day of the year following the individual’s death. There is a federal estate/trust income tax return that needs to be taken care of as well. For this, make sure you file by April 15 of the year following the individual’s death.
Normally these taxes are paid by the executor of the estate. But, in some circumstances the executor can insist that a person who received a non-probate transfer pay their share of these taxes.
Depending upon the date of death and the income received by the person who died before they died, and what income tax returns were completed prior to death, there could be more than one final income tax return of a person who dies.
For example, if someone died in March before filing their taxes for the previous year, and also had significant taxable income in the year that they died, final tax returns might have to be prepared for the year of death and the also for the year prior to death.
Accrued Tax Liens
If an asset received in a non-probate transfer was subject to a tax lien at the decedent's death, the person receiving it takes the asset subject to the tax lien against the person who died on that asset for their unpaid taxes during life (although the tax lien does not create personal liability for the person receiving the asset from assets other than those received in the non-probate transfer).
Taxes Owed By The Person Receiving Non-Probate Property At Someone Else's Death
There are also some other tax obligations that could arise between the date of death and the distribution of an asset that passes via a non-probate transfer such as a beneficiary designation or joint property ownership with right of survivorship.
Income Taxes On Interest Earned On Delayed Life Insurance Payouts
One is that life insurance payouts earn interest for the benefit of the beneficiary after a certain date, if they are not paid by that date, and the interest on the life insurance payout is taxable ordinary income to the person who receives it, although not the face amount of the policy payable which is tax free (except in some obscure exception cases mostly involving viatical settlements).
Income Taxes On Income In Respect Of A Decedent
Another is that "income in respect of a decedent" in taxable in the hands of the person first to receive it after the death of the person to whom it was payable during life. Income in respect of a decedent is income earned by someone before they died but paid after they died. The most common examples are a final paycheck and amounts due in connection with a traditional IRA or 401(k) or other defined contribution retirement savings instrument, or survivor's pension benefits in a defined benefit plan.
Income in respect of a decedent is counted for federal and state estate tax purposes at its pre-tax value, but the income taxes due on the income in respect of a decedent are deductible for federal and state estate tax purposes.
Income Taxes On Certain Capital Gains
If you inherit a capital assets through on pay on death beneficiary designation or through joint tenancy with right of survivorship, for example, there may also be capital gains income taxation due when the asset is sold, but only if it is sold for more than fair market value on the date of the death of the person from whom it was inherited in a non-probate transfer. Accrued but not yet taxed capital gains through the date of death of the person who died are not taxed to anyone, but there are limits on losses that can be taken on property inherited from someone who has died (regardless of whether it was an inheritance under a will or a non-probate transfer at death).
Typical capital assets include real property, securities like publicly traded stocks, and privately held business interests. It could also include collectibles and commodities (e.g. fine art or gold bars).
Capital assets transferred in kind by gift during life are, as a general rule, taxed by a different method that is beyond the scope of this question called a "carry over basis" rule.
Often property taxes owed by not paid on real property (or in some cases even tangible personal property) that accrued before or after the death of the person who died and left it to a recipient in a non-probate transfer was be paid.
State and Local Transfer Taxes
Finally, some localities have transfer taxes on certain kinds of assets, such as real estate, which could be owed upon the transfer of that asset to the non-probate transfer recipient. For example, most real property in Colorado resort towns and most residences in England are subject to a transfer taxes.
Most states also charge some fee or tax to transfer title to motor vehicles with certificates of title that were owned by someone who died and then transferred via a non-probate transfer at death.