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Understanding Inheritance and Estate Tax

Understanding Inheritance and Estate Tax

October 04, 2022

Inheritance tax and estate tax sound very similar and are both often called “death taxes” but they are different. The key difference between estate and inheritance taxes is who is responsible for paying the tax bill.

Estate tax is levied against someone’s estate (upon death) and is based on the size of the total estate. This is a tax on your right to transfer property at your death. The IRS calculates your “Gross Estate” by adding all of your assets using a fair market value. Then, they will make certain deductions like mortgages, debt and property that pass to surviving spouse/ qualified charities, and other debts. They will use this to come up with your “Taxable Estate”. After this is calculated, they will add in the value of lifetime taxable gifts. Every taxpayer has a lifetime gift and estate tax exemption amount. In 2022, the lifetime exemption increased from $11.7 million to $12.06 million. If you are married, you are able to double the estate tax exemption to $24.12 million.

In 2020, less than 0.1% of estates had to file an estate tax return due to exceeding the exemption amount!  Most of our clients do not have to worry about estate tax at the current levels but there are talks to reduce this. The exemption was doubled under the Tax Cuts and Jobs Act (TCJA) and is set to expire in 2026. This is something that we are actively monitoring and will keep our clients updated on.

Inheritance tax is levied against the heirs of an estate. An inheritance tax is a state tax that you pay when you receive money or property from the estate of a deceased person. Unlike the federal estate tax, the beneficiary of the property is responsible for paying the tax, not the estate. Once the executor of the estate has divided up the assets and distributed them to the beneficiaries, the inheritance tax comes into play. The tax amount is calculated separately for each individual beneficiary, and the beneficiary must pay the tax. The federal government does not have an inheritance tax, but six states do. The six states are:

  1. Iowa
  2. Kentucky
  3. Maryland
  4. Nebraska
  5. New Jersey
  6. Pennsylvania

In all six, transfers to surviving spouses are entirely exempt from the tax. In four states—Iowa, Kentucky, Maryland, and New Jersey—transfers to surviving children and grandchildren are also exempt from the tax. Generally, higher inheritance tax will be paid by those who inherit property from someone that was not family.

Please reach out if you have any questions and would like to talk about this further.