Estate vs. Inheritance Tax: What Are the Differences?

Currently, only 1 in 700 deaths in the US merits a federal estate tax, with more than 99.9% of estates going scot-free.

If you thought Uncle Sam was going to give you a break because you lost a loved one, think again. The estate or inheritance you receive as a beneficiary of the decedent might be subject to taxation.

It’s not uncommon for people to use the terms “estate tax” and “inheritance tax” interchangeably. These taxes apply both at the state and federal levels. Knowing how to differentiate between estate vs. inheritance tax will help you breeze through the entire process and plan your finances accordingly.

Read on as we highlight the major differences between inheritance tax and estate tax.

What Is Inheritance Tax?

Inheritance tax is a state-specific tax that one is obliged to pay on the assets they receive from a deceased person as an inheritance. The amount they have to pay depends on the deceased’s state of residence, the value of the inheritance, and their relationship with the deceased.

Some regions may refer to inheritance tax as “death duty.” Again, not everyone that loses a parent or guardian is subject to inheritance tax. Whether you meet the criteria for paying this tax depends on your relationship with the deceased and the amount of inheritance you receive.

There is no inheritance tax at the federal level, and only six states impose inheritance tax on their residents. These states are:

• New Jersey
• Nebraska
• Iowa
• Maryland
• Pennsylvania
• Kentucky

The state is responsible for assessing how much taxes you owe after losing a loved one. We’ll look at a few ways to minimize your inheritance tax later on.

What Is Estate Tax?

Just like inheritance tax, the estate tax is a tax on a person’s assets after they pass on. This tax ranges from 18% to 40% of the decedent estate. Descendants of the deceased will have to pay this tax if they meet the criteria, but the deceased’s spouse is exempt from this tax.

As of 2021, only estates worth more than $11.7 million are subject to inheritance tax. That means if your loved one bequeathed you less than $11.7 million, you’re off the hook. What’s more, not all states impose estate taxes on their residents.

Only 11 states have estate taxes, including Connecticut, Rhode Island, Vermont, and Washington. You’ll have to check in with state authorities to know whether you’re obligated to pay estate tax. If so, the IRS will furnish you with further details on the same.

Form 706 from the IRS will clearly show you how much estate tax you owe on the estate you receive. The form shows what assets the IRS taxes and how they arrive at the figure.

Estate vs. Inheritance Tax: The Differences

On the surface, inheritance and estate tax seem pretty similar. Both of them are death taxes and are charged on the deceased’s property. So what makes estate tax different from inheritance tax?

Here are the main differences between these two death taxes.

The Taxpayer

The most significant difference between inheritance and estate tax is the person responsible for paying the said taxes. For inheritance tax, the inheritor or heir is responsible for paying the inheritance tax. On the other hand, the IRS charges estate tax on the deceased’s property.

This means that estate tax doesn’t take into account who inherits the property. Inheritance tax is an obligation of the deceased beneficiary. If there is more than one beneficiary, all of them will have to pay inheritance tax if they meet the criteria.

The States That Collect Them

As mentioned above, only six states collect inheritance tax, with Maryland collecting both inheritance and estate tax. On the other hand, only 11 states collect estate taxes alone. These states will value the tax based on the value of the deceased’s assets minus debt.

How the Taxes are Calculated

First off, the estate tax only applies to those with estates valued above $11.7 million. This locks out a large chunk of the population from paying estate tax.

If the deceased property has a value of more than $11.7 million, they’ll first have to pay a base tax. On top of that, they also have to pay a progressive rate of between 18% and 40% of the value above the threshold.

For instance, if your estate is worth $14 million, the IRS will subtract $11.7 million from the $14 million. They will then charge between 18% and 40% of the difference as the estate tax.

Like with estate tax, the IRS calculates inheritance tax on the amount above the exemption amount. You’ll have to pay a percentage of the amount above the exemption. This can be anywhere from single-digit percentages to 18% of the amount above the threshold.

It’s worth noting that the closer you are to the deceased, the higher your exemption is likely to be. Plus, you’ll also have lower rates compared with beneficiaries that are not so closely related.

Can I Avoid or Reduce Federal Estate Taxes?

Yes, it’s possible to reduce or even avoid the taxes on your estate before you die. Here are a few tips to do just that.

Spend Your Assets

The easiest way to sidestep the taxman before you die is to spend your hard-earned wealth. You can even sell an inherited house and spend that money as you wish.

Spread Your Assets

Give parts of your estate to your loved ones as gifts. Remember, most states exempt gifts from taxation.

Create a Trust for Your Assets

Create an irrevocable trust to protect your estate from tax. This is a legal way to avoid any taxation on your estate when you die.

Death Taxes: Estate vs. Inheritance Tax

Comparing estate vs. inheritance tax shows some not-so-obvious differences. However, now that you know all of them, you can make proper financial arrangements for whatever you inherit. Liaise with an accountant to find out how you can reduce these taxes or avoid them completely.

For more informative content, check out the other posts on the site.

Originally published at Arabian Post.