Estate taxes and inheritance taxes…

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Clients are often understandably confused about the effect of so-called death taxes on their estate planning.  To start, the term “death taxes” usually refers to two separate taxes:  estate tax and inheritance tax.  These taxes are different, as explained below.

An estate tax is a tax imposed on the estate (not the beneficiary of the estate) by the federal government and some state governments.   The gross estate of a person who has died is all the property owned at death by the person, along with certain property transferred during that person’s life in which an interest was retained and property transferred in contemplation of death.   This would include all joint property, retirement benefits and life insurance proceeds.

Estate taxes are chargeable to the estate of the deceased after deductions and exemptions.

The federal government has an estate tax.  Currently, less than 20 states have an estate tax and Missouri is currently not one of them.

For 2013, the federal estate tax only kicks in if a person dies with an estate of higher than $5.25 million dollars, which is the exempt amount for an individual.   The rate is 40%.  As an example, if a single person died with an estate worth $6 million, they would have a taxable estate of $750,000 ($6 million less $5.25 million), leaving an estate tax bill of $300,000.

It should be noted that couples now have “portability” in their exemptions.  This means that when the first spouse passes away, their individual $5.25 million exemption is transferred to the surviving spouse and when the surviving spouse dies, their exemption is actually $10.5 million.

The problem with the estate tax is that it is subject to change.  As I often tell my clients, while it’s reassuring to know that the estate tax currently only affects multimillionaires, as recently as a few years ago, the federal estate tax kicked in at $675,000.  In 1981, the estate tax kicked in at $175,000.   We simply don’t know what the future holds in terms of estate tax rates and rules.  As everyone knows, our country is deeply mired in debt and at some point this debt will either come due or the federal government will institute higher taxes to pay down the debt.  Whether that would include lowering the exemptions for estate tax is anyone’s guess at the moment.

An inheritance tax differs from an estate tax in that an inheritance tax is imposed on the beneficiary rather than on the estate of the person who passed away.  Depending on the state, it is generally calculated based on who received the inheritance and how much they received.  Typically, immediate family members (children for example) are taxes less than less immediate family members (siblings, uncles, cousins for example).  Only seven states currently collect inheritance tax from beneficiaries and Missouri is again currently not one of those states.  Inheritance taxes are generally taxed at a much lower rate, as are state income taxes.