Death Tax at a Glance: Understanding Estate Taxes and Inheritance Taxes
Death and taxes are often mentioned in the same breath. Estate taxes and inheritance taxes are the two types of taxes that are imposed upon a person’s death. The terms estate taxes and inheritance taxes are often used interchangeably, but they refer to two different types of taxes.
Estate taxes are levied on a deceased person’s estate and are payable by the estate. Inheritance taxes, on the other hand, are levied on the assets that heirs and beneficiaries receive from the estate.
In this article, we will take a closer look at both estate taxes and inheritance taxes, including their history and current laws.
History of Estate Taxes in the United States
Estate taxes have a long history in the United States. In fact, the first estate tax was enacted in 1797 as a method of funding military operations. At that time, the tax only applied to estates worth more than $50,000.
In 1916, Congress passed the first modern estate tax laws. These laws levied a tax on estates worth more than $50,000 and set the rate at 1%. The estate tax laws were updated several times in the following years, with significant changes made in the 1920s, 1940s, and 1980s.
Current Estate Tax Laws
The current estate tax law was passed in 2017 under the Tax Cuts and Jobs Act. Under this law, the estate tax exemption was increased to $11.58 million per person, up from $5.49 million in 2017.
This means that a person can now leave up to $11.58 million to their heirs without owing any federal estate taxes. For married couples, the exemption is doubled, which means that a married couple can leave up to $23.16 million to their heirs without owing any federal estate taxes.
However, it is worth noting that some states have their own estate taxes, which may apply even if federal estate taxes do not. For example, as of 2021, New York has an estate tax exemption of $5.93 million, while Massachusetts has an exemption of $1 million.
How Estate Taxes are Calculated
If an estate is worth more than the exemption amount, the excess is subject to estate taxes. The estate tax rate is currently set at 40%.
For example, if a person’s estate is worth $12 million and the exemption amount is $11.58 million, the excess amount subject to estate tax is $420,000 ($12 million – $11.58 million). The estate tax owed would be $168,000 ($420,000 x 40%).
How Estate Taxes are Paid
Estate taxes are typically paid by the executor of the estate. The executor will need to file a federal estate tax return (Form 706) within nine months of the person’s death. If an extension is granted, the return must be filed within 15 months of the person’s death.
If the estate owes estate taxes, the executor is responsible for paying them. If the estate has insufficient funds to pay the taxes, the executor may need to sell assets to raise the necessary funds.
History of Inheritance Taxes in the United States
Inheritance taxes are a more recent development than estate taxes. The first inheritance tax was enacted in Pennsylvania in 1826, with other states following suit in the years that followed.
In the early 20th century, many states had inheritance taxes, but they fell out of favor as the federal estate tax became the primary method of taxing the transfer of wealth.
Today, only six states have inheritance taxes: Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. Indiana and Tennessee used to have inheritance taxes, but they were repealed in 2013 and 2016, respectively.
Current Inheritance Tax Laws
In the states that have inheritance taxes, the tax rate and exemption amount vary. For example, in Pennsylvania, the inheritance tax is levied at a rate of 4.5% to 15% depending on the relationship between the deceased and the beneficiary. Spouses are exempt from the tax, while siblings and children of the deceased pay the lowest rate.
In Nebraska, the inheritance tax is levied at a rate of 1% to 18% depending on the relationship of the deceased and the beneficiary. The exemption amount is $40,000 for heirs who are siblings or children of the deceased, and $15,000 for all other heirs.
How Inheritance Taxes are Paid
Inheritance taxes are paid by the heirs or beneficiaries who receive assets from the estate. The executor of the estate is responsible for notifying the beneficiaries of their inheritance tax obligations.
The beneficiaries must typically file a state inheritance tax return and pay the tax within a certain period of time. In some cases, the executor may need to withhold a portion of the inheritance to cover the expected tax liability.
Pros and Cons of Estate and Inheritance Taxes
Estate and inheritance taxes are often controversial. Supporters argue that they help to prevent the concentration of wealth in a small percentage of the population, and can help to fund government programs and services.
Critics argue that estate and inheritance taxes are punitive and discourage entrepreneurship, investment, and wealth creation. Some also argue that these taxes are unfair because they are paid on money and assets that have already been taxed during a person’s lifetime.
Estate and inheritance taxes are complex topics that can be difficult to navigate. While the laws and regulations surrounding these taxes are constantly evolving, it is important to understand the basics of how they work.
By understanding the history, current laws, and pros and cons of estate and inheritance taxes, you can make informed decisions about your own estate planning and wealth transfer strategies.
The death tax is also known as the estate tax or inheritance tax, depending in the jurisdiction. Federally, the death tax is the estate tax, which is imposed on the value of the estate before it is distributed to beneficiaries.
There has been great controversy surrounding the death tax in the United States. Although the tax is not applied until after all expenses for the funeral have been paid, as well as monies due to creditors, the percentage of the death tax can include payment of over half the value of the estate to taxes.
Critics of the estate tax or the death tax, argue that subtracting the expense of a funeral from the value of the estate, is not a substantial exemption. Instead, the death tax is imposed on the full value of the estate as a percentage that increases as the value of the estate increases, making those with more substantial estates being subjected to higher rate of taxation.
Critics argue that the death tax discourages savings and entrepreneurship. Those that save know that a majority if their savings will be taken for tax purposes, which discourages large savings accounts.
In addition, it discourages hard work, as those that have larger estates believe that the money made by their hard work, will go to taxes, rather than their family. Conversely, those that support the death tax state that no one is entitled to the money made form the hard work of one person, except for that person.