Difference Between an Estate Tax and an Inheritance Tax
Many people are not aware that there is a difference between estate tax and inheritance tax. An inheritance tax is imposed on the beneficiaries of an estate, whereas the estate tax is based on the fair market value of the entire estate. The beneficiaries are responsible for paying the taxes due on what they inherit and this is determined by the amount of the inheritance and their relationship to the deceased.
The property is passed to a surviving spouse does not usually carry a tax on it, but that which passes to children and other family members and friends does. For children there is a deduction of $3,000 allowed and the tax rate on the remainder is usually about 7.5 %. As the relationship between the beneficiary and the deceased gets more distant the deduction decreases to $100 and the tax rate can range from 10% to 30%. There are some states that do not have an inheritance tax at all, so this would not apply.
The federal government imposes an estate tax on all citizens and residents of the United States. However, there is a standard deduction of $1.5 million for exemption and most estates are valued at less than this amount, meaning that the majority of Americans do not have to pay any estate taxes.
With the changes in laws being passed by Congress it is becoming less likely that you will have to pay estate taxes. Currently the deduction for estates is $1.5 million, but this is expected to increase to $3.5 million by 2009. The reason for this is that while $1.5 million may seem to be an exorbitant value, in reality it isn’t. When you are trying to determine the value of your estate you have to look at what each item or piece of property is worth on today’s market. A home that you purchased for $30,000 thirty years ago and enhanced with additions and improvements could well be worth over $500,000 today. If you are an avid collector or if you have an old car, although these items may seem very cheap to you, they may be worth a fortune. If you have any amount of property that you rent, stocks and bonds, cash savings, life insurance policies or annuities, your estate might well exceed the allowable exemption. After your death the person you choose to be the executor will have to collect all the assets you have along with any debts and submit an estate tax return within nine months. Then the IRS will determine how much taxes the estate has to pay. For large estates, this could be very high, often as much as 48% of the amount over the allowable limit.
There are ways that you can avoid having to pay the government a lot of money in estate taxes. During your lifetime, you are allowed to give gifts totalling $1 million to family and friends to avoid paying taxes on them. You can set up an irrevocable life insurance trust that owns the policies on your life. If you die within three years of setting up this trust, it is considered part of the estate. You are allowed to transfer unlimited amounts of money to your spouse tax-free, provided that your spouse is an American citizen.
You can give gifts of up to $11,000 to an individual every year, if you wish, without paying federal tax on it or having it come off the allowable gift limit of a million dollars. If you and your spouse want to make joint gifts and file joint taxes, then this amount rises to $22,000 a year. This is just one example of how you can pass along inheritances to your children and friends without incurring them any stress of taxes after you die and it also frees your estate from having to pay out a lot of taxes on the value.
