What is the Difference Between Inheritance Tax and Estate Tax?
The property and assets that a person leaves behind after death may attract estate tax and inheritance tax. How much inheritance or estate tax is charged depends on the state in which you reside, and the value of the property/money left behind. It is essential for the surviving spouse, children, and other beneficiaries to know if these taxes apply to them. Though both these taxes apply after the death of a person, there are significant differences between them.
What is Estate Tax?
Estate tax is charged on the property and assets left by a person after death after debts have been paid off. This tax is to be paid before the property is distributed among the beneficiaries. Most people, however, are not required to pay estate tax because it is charged only on estates worth at least a million dollars.
There exist in the U.S. both federal estate taxes and state estate taxes though many states do not impose state estate tax. In case both these taxes apply, state estate tax is charged in addition to federal estate tax. Any property given to a tax-exempt charity or passes on to the surviving spouse who is a U.S. citizen is exempt from estate tax.
U.S. citizens are charged estate taxes on their gross estates, which includes all property which the deceased person owed, including real estate and assets outside the U.S. Estate tax is charged from 18% up to 40% depending upon the size of the estate.
To pay estate tax, Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return is to be filed within 9 months after the date of the death of the owner. Extension of time to file can be obtained in case delay is anticipated in filing.
Nonresident alien descendants may file Form 706-NA, United States Estate (and Generation-Skipping Transfer) Tax Return to compute and file their estate and generation-skipping transfer (GST) tax liability.
What is Inheritance Tax?
If you inherit property or money of a person after their death, you may need to pay inheritance tax. Unlike estate tax, which can be imposed both at the federal and the state level, inheritance tax can only be charged by the state. Regardless of where the beneficiary lives, the state in which the property of the deceased is situated, inheritance tax needs to be paid in that state. However, not all states impose inheritance tax. Some states may impose inheritance tax and some may impose estate tax. Maryland is the only state that charges both inheritance tax and estate tax.
Though estate tax is charged on the total value of the estate, inheritance tax is paid on the value of the inheritance you received. You only pay tax on your share of the inherited property. Though each state has specific rules regarding inheritance tax; generally, the surviving spouse does not pay any inheritance tax. The children of the deceased may pay a lower tax rates or no taxes depending upon the inheritance tax rules of that state. Relatives are charged a higher tax rate than the deceased’s children. As a general rule, the distant the relationship of the beneficiary with the deceased, the more in taxes the beneficiary needs to pay.
Whereas in federal estate tax, the estate pays the tax before it is transferred to the beneficiaries; inheritance tax is paid by the beneficiaries after they receive their share of the inherited property. Each beneficiary pays inheritance tax separately on his/her part of the property.
Knowing if your state imposes estate tax or inheritance tax is important if you are inheriting property, money, or assets after the demise of a loved one so that you can report accurately on your return. Lack of knowledge or ignorance of tax laws is not accepted as an excuse by the IRS and may result in IRS collection actions if you owe inheritance or estate tax and did not pay. If you are unsure of what you owe and how much, you may consult a CPA, tax attorney or an enrolled agent to understand your tax obligations regarding inheritance tax and estate tax in order to stay compliant and avoid incurring tax debt.