While the terms “estate tax” and “inheritance tax” are often used interchangeably, they are not synonymous. Let’s try to clarify the difference.
Estate tax is based on the net value of the deceased owner’s property. An estate tax is applied to these assets when they are transferred to the beneficiary. It is important to remember that an estate tax doesn’t have anything to do with the beneficiary or that person’s resources.
Federal estate tax only affects individuals who die with multi-million dollar estates. There is a federal estate tax exemption that allows individuals to pass anything under the exemption amount free from any estate tax liability. In the last decade the exemption amount has gone from $1 million to more than $5 million. With proper planning, spouses can combine their estate tax exemption and pass double the individual amount without incurring estate taxes. Ninety-nine percent of the population will not owe federal estate tax upon their death.
In most circumstances, no federal estate tax is levied against spouses. Federal estate taxes can, however, be charged if the spouse who is the beneficiary is not a citizen of the U.S. In such cases, though, a personal estate tax exemption can be used.
Many states have their own estate taxes. The state estate tax exemption limit may differ from the federal estate tax exemption limit. In Minnesota the state estate tax exemption limit is approximately $2 million.
Inheritance tax, as distinguished from estate tax, is imposed by state governments and the tax rate depends on the person receiving the property, and, in some locations, on how much that person receives. Inheritance tax can also vary depending upon the relationship between the testator and the benefactor. In Pennsylvania, for example, a spouse is not taxed at all; a lineal descendant (the child of the deceased) is taxed at 4.5 percent; a sibling is taxed at 12 percent, and anyone else must pay 15 percent. Minnesota does NOT have an inheritance tax.
There are exemptions that can reduce the amount of inheritance tax owed by significant amounts, but it is important that there be proper documentation of such exemptions for them to be applicable. Any part of the inheritance that is donated to charity does not require inheritance tax payment on the part of the beneficiary. Because of the inherent complexities of tax law and the variations from state to state, working with a tax attorney who has expertise with state tax laws s the best way to make sure you take advantage of any possible tax exemptions or avoidance.