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Most dictionaries define an estate as representing all of the things that a person owns, while an inheritance is defined as the money, property, etc., that is received from someone when that person passes away.
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While elsewhere in the world these terms might be used interchangeably, in the United States there is a difference between estate and inheritance, mostly form the taxation point of view.
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Our purpose here is to provide you with some basic information on the difference between estate and inheritance taxes.
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The key difference between estate and inheritance taxes lies in who is responsible for paying them. An inheritance tax is based on who receives a deceased person's property and how the beneficiary is related to the deceased person, while an estate tax is based on the value of the deceased person's estate and not on who inherits what.
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The estate tax is imposed by a state or federal government on the right to transfer property to your heirs after your death.
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Being a tax on your right to transfer property at your death, the estate tax consists of an accounting of everything you own or have certain interests in at the date of death. The fair market value of these items is used, not necessarily what you paid for them or what their values were when you acquired them. The total of all of these items is your Gross Estate. The includible property may consist of cash and securities, real estate, insurance, trusts, annuities, business interests and other assets.
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Once you have accounted for the Gross Estate, certain deductions (and in special circumstances, reductions to value) are allowed in arriving at your Taxable Estate.
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These deductions may include mortgages and other debts, estate administration expenses, property that passes to surviving spouses and qualified charities. The value of some operating business interests or farms may be reduced for estates that qualify.
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| After the net amount is computed, the value of lifetime taxable gifts (beginning with gifts made in 1977) is added to this number and the tax is computed. The tax is then reduced by the available unified credit. |
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Most relatively simple estates (cash, publicly traded securities, small amounts of other easily valued assets, and no special deductions or elections, or jointly held property) do not require the filing of an estate tax return. A filing is required for estates with combined gross assets and prior taxable gifts exceeding $5,250,000 in 2013, $5,340,000 in 2014, $5,430,000 in 2015, and $5,450,000 in 2016.
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Apart from the federal estate tax, the following states collect their own tax on residents’ estates: Connecticut, Delaware, District of Columbia, Hawaii, Illinois, Maine, Maryland, Massachusetts, Minnesota, New Jersey, New York, North Carolina (repealed for deaths as of January 1, 2013), Ohio (repealed for deaths as of January 1, 2013), Oregon, Rhode Island, Tennessee (eliminated as of January 1, 2016), Vermont, and Washington.
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The inheritance tax is imposed by a state government on the privilege of certain heirs to receive a deceased person's assets.
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The federal government does not have an inheritance tax.
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| The following six states collect an inheritance tax: Iowa, Kentucky, Maryland, Nebraska, New Jersey and Pennsylvania (Indiana's state inheritance tax was repealed effective January 1, 2013). In all these six states assets left to a surviving spouse are exempt from the tax, but only four states exempt transfers to descendants. |
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| 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. |
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| Estates that aren’t large enough to pay federal estate tax may be subject to a state tax. For example, in Maryland, estates valued at more than $1 million may be taxed. Still, most estates don’t owe either state or federal estate tax. State tax rates are much lower than federal ones. |
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| Depending on your relationship to the decedent, you may receive an exemption or reduction in the amount of inheritance tax you must pay. For example, most states exempt a spouse from the tax when they inherit the property from a husband or wife. Children and other dependents may qualify for the same exemption, though in some cases, only a portion of the inherited property may qualify. |
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Generally, the higher rates of tax will be paid by those who inherit property from a decedent with whom they have no familial relationship.
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| Of course, state laws are subject to change, so if you are receiving an inheritance, check with your state's tax agency. The tax rates on inheritances can be as low as 1% or as high as 20% of the value of property and cash you inherit. In Pennsylvania, for example, lineal descendants will pay 4.5 % inheritance tax, siblings are taxed at 12%, and anybody else at 15%. The state would require you to report this information on an inheritance tax form. |
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| One of the more common means of protecting inheritance from taxes is to place money into trusts and elect a trustee to transfer the property to your beneficiaries upon your death. Once money has been allocated into a trust it is removed from your listed estate and, upon your death, it will be distributed to your heirs free from estate and inheritance taxes. |
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| Some people also choose to give their money in the form of gifts to organizations and establish a charitable gift annuity. Receiving money from an annuity protects your heirs from paying any inheritance tax, although they may still be responsible for an early withdrawal penalty from the IRS. |
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| Generally, property you receive as a gift, bequest, or inheritance isn't included in your income. However, if property you receive this way later produces income such as interest, dividends, or rents, that income is taxable to you. |
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If property is given to a trust and the income from it is paid, credited, or distributed to you, that income also is taxable to you. If the gift, bequest, or inheritance is the income from property, that income is taxable to you.
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| Perhaps the most important thing you need to know about an estate or inheritance tax is that the inheritance, estate, and gift tax codes are some of the most complex in the entire Internal Revenue Code, therefore an attorney or accountant should be consulted in situations that involve such matters. |
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