Difference Between Inheritance and Estate Tax

When someone passes away, their assets, including property, investments, and savings, typically get passed on to their heirs. While inheriting assets can be a windfall for the recipients, it may also trigger certain taxation requirements. Two of the most common taxes that are associated with passing on assets are inheritance tax and estate tax. Even though their names might sound similar, these taxes differ in who pays them, how they get calculated, and how they impact the inheritor.

In this article, we’ll explore the distinction between inheritance tax and estate tax, what they entail, and the latest updates on their regulations.

What is Inheritance Tax?

Inheritance tax is a type of tax that the beneficiary of an inheritance has to pay on the total value of the assets they inherit. The amount of tax that the heir has to pay depends on various factors such as the relationship with the deceased, the value of the property inherited, and the location of the estate. In some places, the inheritor may not have to pay any inheritance tax at all, depending on the state’s threshold for exemption.

This tax is generally on a sliding scale; the closer the relationship between the deceased owner and the inheritor, the lower the amount of tax that will have to be paid. The rate of this tax varies from 0% to 40% on the value of assets inherited.

Moreover, inheritance tax is also known as “”death tax”” since it is imposed when the owner of the assets dies. For instance, if a parent bequeaths assets to their children, inheritance tax is usually payable by the children, and the tax is calculated based on the total value of the estate the children inherited.

What is Estate Tax?

Estate tax is a type of tax that’s imposed on the overall estate of a decedent. The tax is calculated using the fair market value of all of the assets the decedent owned at the time of their death, including cash, stocks, bonds, real estate, and any other assets.

Estate tax has a threshold amount of exemption, and the tax rate rises after the threshold is exceeded. Estate tax is a federal tax, and the latest exemption threshold, postponed until December 31, 2025, is $11.7 million per person.

The estate tax applies to all estates, regardless of the inheritor’s relationship to the deceased, unlike the inheritance tax, which varies based on the inheritor’s relationship. The estate tax imposes the same tax rate on any goods covered, regardless of the relationship between the deceased and the heir.

Differences Between Inheritance Tax and Estate Tax

After discussing the definition of inheritance tax and estate tax, it’s time to look at the differences between the two taxes. Here are a few things that distinguish inheritance tax from estate tax:

– Who pays the Tax?

As we saw earlier, the estate tax applies when someone passes away and concerns the decedent’s property. The tax is paid by the decedent’s estate before any assets can be distributed to heirs. Estate tax is typically handled by the executor of the estate.

Inheritance tax, however, applies to the recipient, not the estate of the deceased. The tax is owed by the inheritor and is only paid if the inheritance value exceeds the threshold established by the specific state.

– Method of Calculation

The calculation method is different for both taxes. The estate tax is calculated by assessing the value of the decedent’s property, whereas the inheritance tax is assessed on the value of the assets received by the inheritor.

– Exemption Threshold Amount

Another significant difference between the two taxes is the exemption threshold amount. This threshold determines whether the tax is applicable or not.

The estate tax has a higher exemption threshold than the inheritance tax. The federal estate tax exemption threshold is $11.7 million, which means any estate assets below the threshold are exempt from taxation. Conversely, the threshold for inheritance tax is dependent on the state of residence.

– Relationship between the Inheritor and Decedent

As previously stated, the inheritance tax is based on the inheritor’s relationship with the decedent, whereas the estate tax is not. The inheritance tax may have lower tax rates for immediate family members, such as a spouse or children, whereas the estate tax is the same rate for everyone.

– State Regulations

The rules and regulations for inheritance tax and estate tax differ by state. Some jurisdictions impose both, some only one, and some have none.

Furthermore, the laws are continuously changing, and the threshold exemption amounts are frequently adjusted based on the current economic circumstances.

Recent Updates on Inheritance and Estate Tax

Due to the constant fluctuations in taxation laws, it’s essential to stay updated on any recent changes. Here are some of the most recent updates on inheritance and estate tax from the US government resources:

– Late in 2020, the Internal Revenue Service (IRS) announced an increase to the estate and gift tax exemption threshold amount for 2021 to $11.7 million per individual.

– As of July 1, 2021, the Uniform Trust Decanting Act (UTDA) has been amended. The act allows beneficiaries to receive distributions of inherited property more quickly.

– As of 2021, inheritances are not taxable at the federal level. This policy applies to the receivable amount by the inheritor and any capital gains from the inherited property when sold.

– On the other hand, a few states in the US do have inheritance tax. Maryland was the most recent state to remove the inheritance tax in 2019.

– Some states also have varying tax rates imposed, for example, New Jersey has an inheritance tax rate of up to 16%.

Conclusion

Both inheritance tax and estate tax are taxes on inherited property, but they work differently. Estate tax is calculated based on the total value of the deceased person’s estate, and inheritance tax is calculated based on the amount inherited by the recipient and their relationship with the deceased.

Not all states impose an inheritance tax, and the threshold for exemption, the tax rate, and the rules vary by state jurisdiction. Federal inheritance tax does not apply to most individuals, although the estate tax still applies. As with most tax laws, the government regulations are continually evolving, so staying up-to-date on current trends and rulings could potentially impact one’s future inheritance and estate planning.

The difference between the estate tax and the inheritance tax is quite easily defined. The estate tax is imposed on the value of the estate when the benefactor passes away. However, the value of that estate may be altered before any beneficiary inherits from that estate. There are some allowable deductions, such as funeral expenses, which lower the tax burden on the estate.

Yet, if the value of the estate were to drop the next day, due to a stock market crash for instance, the estate tax would still be imposed on the value of the estate on the day the benefactor passed away. Whereas, the inheritance tax is imposed on the value of property a beneficiary inherits. If the beneficiary inherits only a portion of the estate, then the inheritance tax would be on the value of that portion of the estate.

The estate tax is imposed on the value of the estate, on the very day that the benefactor passes away. While some assets, such as stocks, may substantially increase or decrease in value, the tax is imposed on the value of the stocks, on the day the benefactor dies. In addition, the estate tax is levied after allowable deductions, such as the cost of funeral and any benefactor debt, have been deducted form the value of the estate. In many cases, estates are subjected to an estate tax on the federal and state level. Each state will have varying allowable deductions on the estate tax.

Inheritance taxes can also be reduced, or subject to exemptions. In many states, spouses, or children, can inherit money tax free, or face reduced inheritance taxes. In addition, spouses that share property jointly, are likely to be able to avoid the inheritance tax on that property. In addition, if a benefactor leaves all, or part of their estate to a charity, the charity can avoid the inheritance tax. In other cases, the beneficiary is responsible for the full inheritance taxes placed as tax burden on the specific amount inherited.

In some case, benefactors and beneficiaries may be subjected to the estate tax and inheritance taxes. However, due to a lapse in Federal laws, there is no federal estate or inheritance tax in the year 2010. In response to that lapse, several states have also allowed their inheritance taxes and estate taxes to lapse, at least for now.  The tax revenue from the estate tax and the inheritance tax is estimated to be very beneficial to the tax jurisdictions that impose them.