What’s the Difference Among Death Taxes, Estate Taxes and Inheritance Taxes
Death taxes is a broad term used to describe the estate taxes and inheritance taxes imposed by the Federal and state governments when you die. Whether tax will actually be due depends on many factors. Likewise, who pays the tax depends on many factors. For example, the estate tax is an excise tax on the deceased person (the “decedent”) for the “privilege” of giving property at death to another. The inheritance tax, however, is a tax on the person receiving the property from the decedent. Often the tax clause in the decedent’s Last Will & Testament provides that both the estate taxes and inheritance taxes are paid from the decedent’s probate estate.
Inheritance tax is state specific, meaning the Federal government does not impose an inheritance tax. Maryland imposes both an estate tax and an inheritance tax. Whether inheritance tax will be due depends on the person receiving the property rather than the amount of property (with two exceptions).
Persons exempt from inheritance tax include:
- Parents and Grandparents
- Children and other lineal descendants, i.e. grandchildren, great-grandchildren, etc.
- Spouses of children and spouses of other lineal descendants
- Surviving spouses of deceased children and other deceased lineal descendants;
- Brothers and sisters
- Tax-exempt organizations, i.e. churches, charities, etc.
For purposes of this exemption, the term children include stepchildren and former stepchildren and the term parent includes stepparent and former stepparent.
Accordingly, the 10% inheritance tax applies to Pet Trusts, friends, nieces and nephews, aunts and uncles and more remote relatives.
Certain property is exempt from inheritance tax, including:
- A gift of $1,000 or less under a Last Will & Testament to one person
- The first $500 passing under a Last Will & Testament for the perpetual upkeep of graves
- Life Insurance proceeds (except when paid to the insured’s probate estate)
- Property passing under a Small Estate
- Income earned during the administration of a probate estate
- Joint primary residence owned by qualified domestic partners
- Reparation and restitution for Holocaust victims
Who pays the Inheritance Tax?
The recipient of the property bears the ultimate responsibility of paying the inheritance tax if not paid by others. Often the decedent’s Last Will & Testament states in the tax clause that all inheritance taxes will be paid from the probate estate. This means that all inheritance taxes will be paid from the residuary estate regardless of whether the property passes under the Last Will & Testament or not. See Does All My Property Pass Under my Last Will & Testament.
If you die without a Last Will & Testament (Intestate) or if there is no tax clause in the Last Will & Testament (or it specifies otherwise), then who pays the inheritance tax depends on how the property is owned. Property owned individually by the decedent becomes probate property and the executor (personal representative) is responsible for paying the inheritance tax before making the residuary distribution to the beneficiaries. For non-probate property, i.e. property passing outside of the Last Will & Testament, the person receiving the property pays the inheritance tax.
Paying Inheritance Tax on Inheritance Tax?
Sounds like a tautology but the answer is Yes: There is an inheritance tax on the amount of inheritance tax paid in certain situations. The premise begins with the recipient of the property bearing the ultimate responsibility of paying the inheritance tax. The 10% inheritance tax is imposed on the amount of property received by the recipient. If the inheritance tax is paid by another (like under a tax clause in a Last Will & Testament), then this payment of inheritance tax is deemed to be another gift to the recipient subject to inheritance tax. This second payment of inheritance tax is deemed to be another gift to the recipient subject to inheritance and so on and so on. This situation typically arises when the tax clause in a Last Will & Testament specifies the payment of all inheritance taxes and (1) there are specific gifts of more than $1,000 to non-exempt persons and (2) non-probate property passes to non-exempt persons. To resolve the mathematical round-robin calculation, the inheritance tax rate is set at 11.1111% in these situations.
Is There an Inheritance Tax Return?
For probate property, there is no inheritance tax return to file. The Administration Account shows the calculation of the inheritance tax and serves as a type of inheritance tax return. The inheritance tax is paid at the time the Account is filed.
For non-probate property, there is the Application to Fix Inheritance Tax on Non-Probate Property. If the tax clause in the Last Will & Testament provides for the payment of inheritance taxes, then the executor should file the Application to Fix Inheritance Tax on Non-Probate Property. If the decedent died without a Last Will & Testament or if there is no tax clause in the Last Will & Testament (or it specifies otherwise), then the person or persons receiving the non-probate property should file the Application to Fix Inheritance Tax on Non-Probate Property. In each case, the Application to Fix Inheritance Tax on Non-Probate Property is due three months after the decedent’s date of death. The Register of Wills knows who receives non-probate property subject to inheritance tax because the executor of the probate estate must file an Information Report.
The Federal estate tax and state estate taxes have been in a constant state of flux for about two decades. Bills are constantly introduced into Congress to repeal the Federal estate tax, change the exemption amount and change the tax rates. Not all states impose an estate tax and many have increased the amount of the exemption from estate taxes before tax is actually due. Many states, like Maryland, incorporates many of the Federal estate tax laws into the state estate tax laws and then make certain changes for the state tax system for its own purposes. This means we are talking about a moving target. Check back for updates to this article.
The Federal Death Tax System
The Federal death tax system is comprised of several taxes on the transfer of property. In general, everything you own is subject to the death tax system, including:
- Bank accounts and brokerage accounts
- Jointly-owned property
- Life insurance
- Retirement accounts
- Real Property
- Tangible personal property
The estate tax, the gift tax and the generation-skipping transfer tax compose the Federal death tax system. Each of these taxes has an amount of property that is exempt from tax. Property passing from a decedent above the exemption is subject to estate taxation at a 40% tax rate. Likewise, gifts of property above the exemption is subject to gift taxation at a 40% tax rate. The estate tax and gift tax are said to be unified because the use of the gift tax exemption for lifetime gifts effectively uses the estate tax exemption for gifts at death. Each person only gets one exemption to be used for lifetime gifts, gifts at death or a combination of the two. Through the portability rules, a surviving spouse can obtain the deceased spouse’s unused estate tax exemption in certain circumstances. For the surviving spouse to obtain the deceased spouse’s unused estate tax exemption, a federal estate tax return, Form 706, must be timely filed, even if the filing threshold at the deceased spouse’s death is not met or exceeded.
The generation-skipping transfer tax (“GST Tax”) is a tax on property given to or passing to a grandchild or more remote descendant above the GST Tax exemption. It is in addition to the estate and gift tax with a tax rate equal to the highest estate tax rate of 40%.
Maryland Death Tax System
As discussed above, the Maryland death tax system has an inheritance tax. In addition, the Maryland death tax system has an estate tax but does not have a gift tax or a GST Tax. Each dollar paid in inheritance tax is a credit against the Maryland estate tax to avoid double taxation. For Maryland residents, the estate tax is imposed on all of the decedent’s property wherever located; however, real property and tangible personal property with a tax situs outside of Maryland is apportioned when calculating the tax. Like the Federal death tax system, the Maryland estate tax has an amount of property that is exempt from tax. The top tax rate for the Maryland estate tax is 16%.
The Estate Tax Exemption
For 2017, the Federal exemption amount is $5,490,000 per person. This means the first $5,490,000 of property is not subject to tax but tax is paid on amounts over $5,490,000. This exemption applies to the gift tax, the estate tax and the GST tax. The exemption is indexed for inflation which means that it increases to keep pace with inflation. Remember, each person only gets one exemption to be used for lifetime gifts, gifts at death or a combination of the two.
For 2018, the Maryland estate tax exemption is $4,000,000 per person. This means the first $4,000,000 of a decedent’s estate has no estate tax due but estate tax is paid on the decedent’s estate over $4,000,000. In 2019, the Maryland estate tax exemption will equal the Federal estate tax exemption.
Are There Any Transfers Not Subject to Estate and Gift Taxes?
Transfers of property between spouses is not subject to estate and gift taxes because the transfer is entitled to a Marital Deduction. For a transfer to a trust for a spouse to qualify for the Marital Deduction, the trust must be specially designed.
For 2018, the first $15,000 of a lifetime gift to a person is not subject to Federal gift tax. This is known as the Annual Donee Exclusion. For a lifetime gift to a trust to qualify for the Annual Donee Exclusion, the trust must be specially designed. The Annual Donee Exclusion is indexed for inflation.
How We Can Help.
Whether you are administering a decedent’s estate or are concerned about the impact of death taxes, we are here to provide you with guidance and counsel on these matters. Please call us at 410-628-0050 to schedule a consultation.
PLEASE NOTE: These materials are current as of the date of posting and are not a comprehensive discussion of the entire subject matter. They are presented for informational purposes only and should not be considered legal or financial advice as to any specific matter or transaction. They are not intended for the purposes of advertising or soliciting clients, and should not be misconstrued as establishing an attorney-client relationship. Readers should consult a knowledgeable attorney experienced in such matters for legal advice.
Copyright 2017 Rutledge & Aitken, LLC