You may have heard the phrase inheritance tax in reference to estate planning. What is an inheritance tax? As the name suggests, it’s a tax assessed against the share of an estate inherited by an individual. An inheritance tax is separate from an estate tax, which is assessed against the whole value of a deceased individual’s property at the time of his or her death. The estate tax is paid by the estate. Inheritance taxes are generally paid by the recipient.
Estate taxes are more commonplace in the United States than inheritance taxes. There is a federal estate tax but no federal inheritance tax. Only nine U.S. states currently assess an inheritance tax. California is not one of them; it repealed its inheritance tax in 1982. Even the few states that do impose an inheritance tax provide broad exemptions for immediate family members of the deceased.
For example, in Maryland there is an 10% inheritance tax on all after-death transfers, except those to a spouse, child, parent, grandparent or sibling. Thus, if John Smith leaves $100,000 to his sister, there is no Maryland inheritance tax, but if he leaves that $100,000 instead to his sister’s son, that nephew would then owe $10,000 in taxes (unless Smith’s will directed his executor to pay the inheritance tax from the estate).
Besides Maryland, the states that assess an inheritance tax as of May 1, 2013, are Indiana, Iowa, Kentucky, Nebraska, New Jersey, Oklahoma, Pennsylvania and Tennessee. Indiana legislators are in the process of repealing that state’s inheritance tax retroactive to January 1 of this year. Even though California has no inheritance tax, if you’re a California resident who owns property subject to probate in an inheritance tax state–say, a second home in Maryland–then your heirs may be liable if they are not entitled to a local exemption.
How Much Can You Give Away Tax-Free?
Another type of tax that may be confused with the inheritance tax is the gift tax. This is a federal tax imposed on certain transfers of cash and other property during the giver’s lifetime. (Connecticut is the only state that imposes a separate gift tax.) The Internal Revenue Service defines a gift as any transfer where “full consideration” is not received in return. All gifts are taxable, but there are several broad exclusions. Most notably, you may give up to $14,000 in gifts to any person each year without tax liability. This is a per person exemption.
So if you have five children, you may give each $14,000 per year without incurring any gift tax. (The gift tax is usually paid by the giver, not the recipient.) Also, gifts you make for someone else’s medical or educational expenses are excluded and separate from the $14,000 annual limit. You can also make unlimited gifts to your spouse or a political organization.
From an estate planning perspective, the gift tax means you can’t avoid the federal estate tax by simply giving away all of your property before you die. Congress unified the federal estate and gift taxes in 1976 to address this issue. Beyond the $14,000 per person annual exclusion, you can make lifetime gifts of up to $5.25 million–the same exemption level as the federal estate tax–without incurring any gift tax. So let’s say you have $8 million in assets. You could give away $5.25 million of that to your children–plus an additional $14,000 per year to each child until you die–and there would be no gift tax liability.
Obviously, most of us won’t leave estates that large and thus need not worry about gift taxes. But like inheritance taxes, gift taxes are just one of many complex factors to consider when planning your estate. The tax laws themselves are constantly in flux, both federally and state-to-state, and therefore it’s essential to work with a qualified San Diego estate planning attorney who can advise you of all the potential tax issues raised by your estate. If you have any questions, contact the Law Office of Scott C. Soady at 1-877-435-7411.