In the complex realm of estate planning and wealth transfer, understanding the distinctions between estate tax and inheritance tax is crucial. While both terms are often used interchangeably, they refer to distinct concepts that impact heirs differently.
To help you understand these two types of taxes, we made a brief guide.
What Is Estate Tax?
Estate tax is a levy imposed on the total value of a deceased person's estate before it is distributed to their heirs. The tax is calculated based on the net value of the estate, which includes assets like real estate, investments, cash, and personal property.
The federal government and some states impose estate taxes, and the rates can vary. Generally, estates exceeding a certain threshold are subject to this tax, but there are exemptions and deductions that can reduce the taxable amount.
Estate tax is often seen as a transfer tax, as it occurs when the ownership of assets transfers from the deceased to their heirs. Proper estate planning, including the use of trusts and gifting strategies, can help minimize the impact of estate taxes on the overall wealth transfer process.
What Is Inheritance Tax?
In contrast, inheritance tax is a tax imposed on the assets received by individual heirs. Unlike estate tax, which is based on the total value of the estate, inheritance tax is determined by the relationship between the deceased and the heir and the value of the inherited assets. The tax rates may vary depending on the heir's relationship to the deceased, with close relatives often enjoying lower or even exempt tax rates.
Inheritance tax is levied by some states, and not all states have this type of tax. Those states that do implement inheritance tax may have different rules and exemptions, adding another layer of complexity to the process.
Estate Tax Vs. Inheritance Tax
The key difference between estate tax and inheritance tax lies in the timing and the parties involved. Estate tax is paid by the estate itself before distribution, while inheritance tax is paid by individual heirs after they receive their share of the inheritance. Additionally, estate tax is based on the overall value of the estate, whereas inheritance tax considers the value of specific assets inherited by each individual heir.
