Inheritance Tax

What Is Inheritance Tax?

A tax paid by a person or people who receive an inheritance of a deceased person's estate (money or property) is known as an inheritance tax. 

Unlike an estate tax, which the decedent's estate pays, an inheritance tax is paid by the beneficiary of a bequest.

The tax is uncommon in the United States. However, as of 2022, it will either apply in one of the six states (New Jersey, Maryland, Nebraska, Iowa, Kentucky, Pennsylvania) where there is an inheritance tax, depending on the state where the deceased resided or had property, the amount of the bequest, and the beneficiary's relationship to the deceased.

The words "estate tax" and "inheritance tax" is sometimes used synonymously in certain jurisdictions. Although not legal, the tax is also known as the "death duty" in the United Kingdom and a few Commonwealth nations.

The tax is due when the estate is given to the beneficiaries. Most of the time, depending on the share of the estate they received, each heir pays their inheritance tax.

The beneficiary's relationship to the dead individual may influence whether inheritance tax must be paid. For instance, couples often do not have to pay taxes. 

Additionally, the organizations and companies that receive the estate from the deceased individual as a charitable contribution are exempt from paying the tax.

This tax is normally owed by the lineal descendants and ancestors, including: 

• parents, 
• children, 
• siblings, 
• grandparents, and 
• distant relatives and non-relatives. 

However, compared to close relatives, distant relatives and non-relatives often pay a substantially higher tax rate.

The tax is often assessed depending on the estate's valuation. However, in some circumstances, it will only be enforced if the estate's worth is a set threshold.

History Of Inheritance Tax

The federal government has relied on federal estate taxes for finance practically since the country's founding.

When land or dwellings passed from one generation to the next, Congress established a system of government stamps that had to be on every will submitted for probate. 

The money collected from these stamp sales went toward constructing the Navy for an unrecognized conflict with France that had started in 1794. The tax was eliminated in 1802 when the need subsided. 

The tax was repealed and re-enacted several times before being made a permanent part of the federal tax code in 1916.

The estate tax briefly disappeared in 2010. However, the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 was passed by Congress in December 2010. The new law applied tax regulations retroactively to all estates settled in 2010. 2

According to the American Tax Relief Act, the estate tax became a permanent feature of the tax system in 2012.

Over the years, the rate of tax and exemptions has changed several times. In the past, death duty has been controversial, with some arguing that it is a necessary way to fund government programs and others arguing that it is a burden on families and small businesses.

Recently, there has been a trend toward reducing or eliminating the tax in many jurisdictions worldwide. 

Some argue that death duty is unnecessary because it is double since the inherited assets have already been taxed at some point. 

Others argue that this tax is unfair because it disproportionately affects smaller estates and can result in the forced sale of assets to pay the tax.

Calculation and thresholds for inheritance tax

Only the portion of an inheritance that exceeds an exemption level is subject to an inheritance tax if one is required. However, tax is often applied on a sliding scale above such levels. 

More so than the size of the assets you are receiving, your relationship to the dead may affect both the exemption you obtain and the rate you pay.

Generally speaking, the larger the exemption and the smaller the cost you'll pay, the closer your familial connection to the dead was. 

In all six states, surviving spouses are immune from this tax. Also exempt in New Jersey are domestic partners. Only Nebraska and Pennsylvania impose inheritance taxes on heirs.

In most cases, this tax is not applied to life insurance payments made to a designated beneficiary. If the estate or revocable trust was the policy's beneficiary, an estate tax may apply.

Most states impose a death duty on bequests that exceed a specific threshold. Therefore, the size of the estate might be important in some cases.

Depending on how closely connected they were to the dead, there are exemptions for heirs. These specifics are listed by state:

1. New Jersey: 

• Immediate family members (spouse, kids, parents, grandparents, and grandkids) and nonprofit organizations are excluded. 
• Siblings and sons/daughters-in-law are excluded from up to $25,000. 
• Depending on the inheritance's quantity and the family's closeness, the tax rate ranges from 11% to 16%.

2. Maryland: 

• Immediate family members (parents, grandparents, spouses, children, grandkids, and siblings) and charitable organizations are exempt; 
• Other beneficiaries are exempt up to $1,000. 
• There is a 10% tax rate.

3. Nebraska: 

• Immediate family (parents, grandparents, siblings, children, and grandkids) and charities are completely exempt from up to $40,000.
•  Other relatives up to $15,000 and unrelated heirs up to $10,000 are excluded. 
• Above such exemptions, the tax rates are 1%, 13%, and 18%, respectively.

4. Iowa: 

• Exemptions for charity up to $500 and immediate family (spouses, parents, and kids). 
• The death duty rate for others ranges from 5% to 15%.

5. Kentucky: 

• Other receivers are only exempt up to $500 or $1,000; 
• Immediate family members (spouses, parents, children, and siblings) are not exempt at all. 
• The tax has a minimum value plus a percentage that ranges from 4% to 16%, and it is calculated on a sliding scale dependent on the size of the inheritance.

6. Pennsylvania: 

• Spouses and small children are excluded. 
• Parents, grandparents, and adult children are exempt up to $3,500. 
• Depending on the connection, the tax rate ranges from 4.5% to 15%

Methods for Minimizing Inheritance Tax

Several strategies can be used to minimize inheritance tax, depending on the laws of the jurisdiction in which the estate is located and the specific circumstances of the estate. 

Here are some things you may do to prevent paying death duties.

Think Of A Different Valuation Date

The inheritance's worth is typically calculated as of the decedent's passing. But in some circumstances, an executor may select a different valuation date. Six months following the decedent's death date is the alternate valuation date. 

You must honor your decision to use the alternative date after you've made it. In a down market, choosing a different date might benefit you since you would be only responsible for paying taxes on the estate's lower value than it would have been on the day of the death.

The beneficiaries will be spared a significant amount of money in tax responsibilities, and you will be able to avoid or lessen estate taxes.

Think Of Life Insurance As A Means Of Transferring Assets

If you wish to minimize or eliminate estate taxes, you can transfer your assets to your beneficiaries using life insurance payouts. A life insurance payout to a designated beneficiary is practically tax-free at face value and will not be liable to death duty.

Additionally, a payoff from an insurance policy is not regarded as taxable income. Therefore, your beneficiaries won't have to pay any taxes on their inheritance because you lower your estate tax.

Have Faith In A Trust

Whether onshore or offshore, creating a trust is an excellent approach to shield your assets from the probate process and exploitation by beneficiaries. Additionally, a trust gives the grantor or settlor far greater control over how their assets are managed and will be utilized in the future.

Although there are many other types of trusts, we have included the two most popular ones below: 

• Revocable Trust: A revocable trust is completely within the jurisdiction of the settlor or grantor. But, as the name suggests, a revocable trust can be changed or revoked by the grantor at any moment. 

• Irrevocable Trust: As the name implies, the grantor cannot change or revoke an irrevocable trust at any time. It is irreversible once put up properly, not even by the grantor.

Once the trust receives ownership of your estate after you transfer it to it, neither estate taxes nor death duties apply to that portion of the estate. 

This rigidity may seem severe and even counterproductive, yet it is the same thing that shields an individual or a company's assets against later-life abusive claims.

Researched & Authored by Hitesh Sarda | LinkedIn

Reviewed & Edited by Ankit Sinha | LinkedIn

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