What are the differences between an estate tax and an inheritance tax? And should you be worried about the implications of either concerning your estate plan?
Should you be worried about a federal inheritance tax being part of your estate plan?
This post is going to explain the fundamentals of the Federal Estate and Gift Tax, as well as the exemptions and the tax rate.
What is the inheritance tax?
A lot of people consider this tax as being any tax that is collected on an estate of a deceased individual. Better general terminology for this is going to be death tax. Literally, there are two kinds of death taxes:
Inheritance tax. This is a tax that is collected from an individual that receives an inheritance. The individual that receives the inheritance is the individual that needs to file the tax return to state what was received.
Estate tax. This is a tax that is charged to the deceased individual’s estate prior to anything being distributed to their beneficiaries. The individual that oversees the estate (referred to as the personal representative) is the one that is required to file the tax return to state the entire value of the estate.
So, in all actuality, there is not a federal inheritance tax; however, there is a federal estate tax.
Estate taxes and the federal government
The kind of death tax that the US government might impose is an estate tax. The estate’s personal representative is responsible for filing the required documents with the IRS, and for paying any tax that could be owed.
The IRS additionally imposes a tax on specific gifts made by an individual while they are alive. Taxes on gifts made before death and on inheritances are merged in the Federal Estate and Gift Tax.
Estate taxes and state government
Some states additionally impose estate taxes. The exemptions that are applied and the estate or inheritance tax rate differs by state.
Federal Estate and Gift Tax exemptions
The Federal Estate and Gift Tax restricts the amount an individual can transfer without incurring the tax. To the IRS it does not matter whether the wealth is transferred as a gift or following death.
Nevertheless, specific amounts are exempt from being taxed. Congress is continually playing with the amount of those exemptions, which usually change by year. There is also political demands to remove the tax completely.
The primary way the Federal Estate and Gift Tax works is that each amount of gifts and inheritance are added up, then specific exemptions are subtracted from that total. Should the result exceed a specific dollar amount, the tax is imposed on the remainder.
- Federal Gift Tax yearly exemption. There is currently a yearly exemption of $17,000 per individual. Meaning that you can give up to $17,000 per year to as many individuals as you want. A husband and wife can give up to $34,000 each year per person. So, if you wanted, you could give away everything you possess this year without receiving any tax liability, as long as you do not give more than $17,000 to any one individual ($34,000 whey you are married). This exemption covers each year, so you could give an individual $17,000 this year, and $17,000 in each following year, without receiving the liability. That amount can be doubled when you are married.
- Federal Estate and Gift Tax lifelong exemption. When you do give an individual more than the permitted yearly amount, that leftover is going to be added to the worth of your estate at the time of death to establish the amount subject to the combined Federal Estate and Gift Tax. Nevertheless, a lifelong exemption, usually referred to as the unified credit, is going to be applied. For individuals that passed away in 2016, the credit is $5.45 million. In 2017, the unified credit is $5.49 million. Present day law requires that amount of the exemption to be tabulated for inflation every year.
- Spousal exemption. There also is an unrestricted exemption for interchanges from one spouse to the other. You also may use your deceased spouse’s remaining exemption, but you are required to signify a choice to do that on your spouse’s estate tax return (even when no tax is owed from their estate).
Federal Estate and Gift Tax Rate
For 2023, the Federal Estate and Gift Tax rate is forty percent. Meaning that, when the entire value of your estate at your passing, plus any gifts made mor than the annual gift tax exemption, surpasses $12.92 million, the amount above that is going to be subject to a forty percent tax. Like with the exemptions, there is always the potential that Congress is going to change the tax rate for years down the road.
- Is there a federal inheritance tax? LegalZoom. (n.d.). Retrieved February 15, 2023, from https://www.legalzoom.com/articles/is-there-a-federal-inheritance-tax
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