The terms estate tax and inheritance tax are often used interchangeably, which can cause confusion. On the surface, it might seem like the two terms refer to the same tax but, in fact, estate and inheritance tax are two very different things. The largest difference between the two is who is paying the tax; a clue is contained within their names.
Estate taxes are paid by the deceased individual’s estate while inheritance taxes are paid by the person or persons inheriting the assets. Furthermore, estate tax can be imposed by either the federal government or state governments, whereas inheritance tax is only imposed by certain states.
There are nuances when it comes to federal and state estate law, so it’s always important to work with an experienced and qualified estate planning attorney licensed in your state who can collaborate with your financial planner. Let’s explore further.
What is the tax exemption?
Currently, there is a federal estate tax exemption of $11.7M per individual that is set to sunset in 2025 and revert back to the 2018 amount of $5.6M. So, if you pass away with assets totaling $11.7M or less, your estate should not owe federal estate tax.
But just because your estate doesn’t owe federal estate tax, in this example, doesn’t mean it might not owe state estate tax; it all depends on where you live. Certain states have different state estate tax exemption amounts or don’t impose an estate tax at all. Currently, only 14 states and the District of Columbia impose an estate tax. And the other states that do impose an estate tax have varying exemption amounts.
But what about that other tax, inheritance tax?
While there is no federal inheritance tax, there are some states that levy an inheritance tax; six to be exact: NE, IA, KY, MD, NJ, PA. And if you’re lucky enough to live in MD, then you have the pleasure of both an estate and inheritance tax.
Again, inheritance taxes are paid by the person inheriting the assets but just because a state has an inheritance tax doesn’t mean the tax will necessarily be due. Usually, the tax trigger is dependent upon how the beneficiary was related to the deceased. Each of the six states uses a different method for determining if and how much of an inheritance tax is due.
For example, NJ doesn’t apply its inheritance tax to money left to a grandparent, parent, spouse, or child but does apply inheritance tax to certain inheritances received by siblings and other beneficiaries and the rate goes as high as 16%. Conversely, PA levies its inheritance tax on every heir and maxes out at 15%. Confusing, right?
So what’s the key takeaway? No two estate plans are alike and there are various elements such as state of residence, estate size, relationship to beneficiaries, changes to the law, and sometimes even the year of death, which could all have an impact.
The most important estate planning factors, however, are the goals and values of the individual creating the plan. Personal goals and values for one’s legacy should always come first. A good estate planning attorney will recognize this and start with discovery, then explain the estate law and finally will help determine the most beneficial way to structure the plan.