By Barry Zimmer on April 27th, 2021 in Estate Planning
People often harbor misconceptions about the taxes that can be levied on inheritances. You may have heard the term “inheritance tax,” and you have undoubtedly heard mention of an estate tax.
Some folks assume that both of these terms are used to describe the income taxes that must be paid on inheritances.
This assumption is not completely illogical, but it is way off base. First, an inheritor does not have to report a bequest as taxable income to the IRS or the state income tax department.
Secondly, they are two different forms of taxation, and in fact, both taxes could apply to the same estate.
Let’s look at the difference between inheritance taxes and estate taxes so you can go forward with clarity.
Federal Estate Tax
An estate tax is applied on the entire taxable portion of an estate before it is transferred to the heirs. There is a federal estate tax in the United States, but very few families pay it, because there is an exclusion that is quite high.
The exclusion allows taxpayers to transfer a certain amount before the remainder would be subject to the estate tax. At the time of this writing in 2020, the federal estate tax exclusion is $11.58 million.
There are annual adjustments to account for inflation, so the figure will be a bit higher next year. It should be noted that the entire structure can be changed via legislative mandate, and it has been changed many times over the years.
You cannot give gifts to avoid the estate tax because there is a gift tax that has been unified with the estate tax since the 1970s. So, if you give away $11.58 million in taxable gifts and you pass away this year, there would be no exclusion left to apply to your estate.
There is no taxation on transfers between spouses, because there is a unlimited marital deduction. In order to use this deduction, you have to be married to an American citizen.
Since the estate exclusion is portable, a surviving spouse would be able to add their deceased spouse’s exclusion to their own exclusion.
State-Level Estate Taxes
There are some states in the union that have state-level estate taxes, and the exclusions in these states are typically much lower than the federal estate tax exclusion. Here in Ohio, there is no state estate tax.
However, if you own property in a state that has an estate tax and its value exceeds the exclusion there, it would apply to your estate.
Inheritance Taxes
Unlike an estate tax, an inheritance tax can be levied on transfers to each individual inheritor. There is no federal inheritance tax, and there are just six states that have state inheritance taxes.
We do not have one in Ohio, but our neighbors in Kentucky have an inheritance tax. If you were to inherit property that is located in Kentucky, that tax would be a factor, unless you are exempt. Close relatives are in fact exempt from inheritance taxes.
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