The dreaded death tax is one of the more unfortunate parts of estate planning out there. But through smart planning, you can better understand the implications of how these taxes work. And having a deep understanding of what your estate, and your loved ones, may be up against is key to ensuring you’re doing everything you can to minimize or eliminate as much tax as possible.
Types of Federal Taxes and State Taxes Inflicted After Death
There are two types of estate taxes that can be imposed after death. There is a federal tax, where the IRS taxes portions of your estate. And, depending on where you live, there may be state-level taxes due as well.
In addition to taxes due at the federal and state level, there is also another tax, known as an inheritance tax. This final tax isn’t anything that you or your estate would be responsible for. Rather, it’s a tax your beneficiaries would owe based on their inheritance.
What Is a Death Tax?
“Death Tax” is an umbrella term of sorts that was first coined some time in the 1990s. It’s also commonly referred to as estate tax, death duties and or inheritance tax, depending on who is demanding the tax and who is responsible for paying it.
Ultimately, death taxes are just used to describe any tax that’s imposed on either a person’s estate, or on a beneficiary’s inheritance after the estate owner’s death. The key difference in the types of taxes, as noted, is who owes the tax (the estate or the inheritor), and who will benefit from the tax (the federal government - the IRS - or the state). States have varying requirements and guidelines about when, where and how tax is collected from an estate or inheritor. This is why it’s essential to understand the ins and outs of your state tax laws. Important to note, not all states collect estate and/or inheritance taxes.
What Is an Estate Tax?
Federal estate tax is a tax that’s assessed on someone’s property after the owner's death. Taxes can be levied on real estate, cash, stocks or any other assets holding value beyond a specified threshold in a person’s estate.
Currently, as of 2021, that threshold according to the federal government is $11.7m (up from the 2020 $11.58m exemption amount). In addition to this federal-level tax that the IRS imposes, there are 12 states plus Washington DC that all assess estate taxes (or death taxes) on estates holding a value beyond a certain amount.
List of States that Impose an Estate Tax and Federal Tax
Some states require you to pay an additional estate tax on top of the federal government’s tax. These states, and their thresholds as of 2021 are:
Connecticut - $7.1m
Hawaii - $5.49m
Illinois - $4m
Maine - $5.8m
Maryland - $5m
Massachusetts - $1m
Minnesota - $3m
New York - $5.85m
Oregon - $1m
Rhode Island - $1.58m
Vermont - $5m
Washington - $2.193m
District of Columbia - $5.682m
States that Impose a Death Tax
Death tax is also sometimes used to refer to an inheritance tax. Inheritance tax is still a tax that stems from assets in an estate, but the key difference is with an inheritance tax, as we briefly discussed earlier, it’s the beneficiary who’s responsible for paying the tax. The amount of tax owed is based on the amount he or she inherits. While the federal government doesn’t have an inheritance tax, some states do, such as:
Iowa - Tax Rate = 5 - 15%
Kentucky - Tax Rate = 4 - 16%
Maryland - Tax Rate = 10%
Nebraska - Tax Rate = 1 - 18%
New Jersey - Tax Rate = 11 - 16%
Pennsylvania - Tax Rate = 4.5 - 15%
*Rates are current as of 2021
Difference Between an Estate Tax and an Inheritance Tax
The difference between an estate tax and an inheritance tax is simply who is responsible for paying the tax due.
Estate taxes are paid for out of the estate, before any assets are settled or passed on to a beneficiary.
By contrast, an inheritance tax is paid for by the beneficiary, after he or she receives their inheritance. Surviving spouses would never have to pay an inheritance tax.
How much of an inheritance tax is due will ultimately depend on a number of things, including:
What type of asset is being passed
The value of the asset
The relationship between the Grantor (the estate owner) and the Beneficiary
The age of the Beneficiary
Setting up an Estate Plan to thoughtfully plan for and address taxes on all levels isn’t just smart. It's also incredibly important in ensuring that your estate holds as much value as possible, so you can pass on more to those you love and want to benefit from your estate after your death.
There’s no denying that an effective, thorough Estate Plan is key to protecting your wealth and your beneficiaries. Learn more about the power and protection of an Estate Plan. Start your valid, comprehensive Trust, Will or other estate planning documents from Trust & Will today.