Inheritance tax is one of those subjects most people prefer not to discuss. After all, if a person is subjected to this type of tax it is because someone they love has died and left them in charge of their worldly possessions.
There is often confusion about inheritance tax, how it’s assessed, and when it is paid. Confusion stems from the fact that not all states impose inheritance tax and federal inheritance tax is undergoing ratification.
Presently, 11 states assess taxes on inheritance gifts that are passed to heirs and beneficiaries. The only way to know for certain if taxes are owed is to research state inheritance tax laws or consult with a probate lawyer or tax accountant.
Estate assets may also subjected to federal inheritance tax. In 2010, this tax was repealed, but was reinstated in January 2011. Estates valued over $5 million may be subjected to taxation of up to 55-percent. This is a hefty amount; particularly if beneficiaries reside in states that also assess state inheritance taxes.
While people sometimes refer to inheritance tax as estate state, these are two different things. Estate tax is assessed against the gross value of the estate less allowable tax credits and deductions. Inheritance tax is assessed against the gross value of items received through inheritance gifts.
Individuals who engage in estate planning strategies prior to death can reduce the level of taxes levied. The types of strategies depend on value and type of estate assets. Wealthy people often use an irrevocable life insurance trust to accrue sufficient funds to cover estate tax. This type of trust if extremely inflexible and prohibits the insured party from making any changes once it is established.
Another strategy is to transfer assets into a trust to avoid probate. Trusts are normally reserved for estates valued over $100,000. All property that is protected by a trust is removed from the estate and exempt from probate. Inheritance gifts can be distributed to heirs shortly after death. Depending on the type of trust used, gifts may or may not be subjected to taxation.
Probate is required within the U.S. to settle estates that are not protected by a trust. The last will and testament is used to provide directives regarding distribution of inheritance property. The Will is also used to appoint a probate personal representative to settle estate matters.
Two types of gifts can be bequeathed through the last Will and include general and specific gifts. Specific gifts include smaller items such as antiques, jewelry, coin or stamp collections, family heirlooms, and collectibles.
General gifts refer to items that remain after specific gifts are distributed. In most cases, estates consist primarily of general gifts. Beneficiaries that receive general gifts are referred to as ‘principal heirs.’ Every Will must include at least on principal heir which is often the surviving spouse.
When a person dies without a Will, it is referred to as intestate. Inheritance gifts of intestate estates are distributed to rightful heirs according to state probate law.
Federal and state inheritance taxes are not imposed for all types of inherited property. In most cases, spouses are exempt from taxation of both levels. Property gifted to children, relatives, and friends are subjected to federal taxes if the gifts exceed federal guideline levels and if their state of residence levies inheritance taxes.
Internal Revenue Service: Estate and Gift Taxes
About.com: How to Calculate Estate Tax Liability