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Many people assume estate tax and inheritance tax refer to the same thing. That’s not the case. Understanding the distinction between these taxes can help you choose better estate planning strategies to protect your legacy. But what is the difference between these two types of taxes?
What are estate taxes?
An estate tax is based on the net value of the assets of a deceased person at the time of their death. It can include:
- Property
- Money
- Collectibles
- Financial accounts
Certain debts, like a mortgage loan, can decrease an estate’s value. Before being able to distribute the assets to beneficiaries, the deceased person’s estate has to pay off these taxes. State estate taxes vary, and some states don’t have them, while federal estate taxes begin at 18% and can increase up to 40%.
Keep in mind that not everyone needs to pay estate taxes. If the decedent was a resident or citizen of the United States, this estate tax usually only applies to estates worth more than $13.61 million for 2024 and is adjusted each year.
What are inheritance taxes?
Inheritance taxes are those you pay on any assets you receive from a dead person’s estate. Most states don’t impose this type of tax. Some of the ones that do are:
- Pennsylvania
- New Jersey
- Iowa
- Nebraska
- Maryland
- Kentucky
One of the differences between inheritance tax and estate tax is that with the former, the person receiving the assets is responsible for paying the taxes. With estate taxes, the person’s estate does this. The amount you pay depends on how much you receive.
Inheritance taxes are calculated by first determining the value of the estate and then deducting any liabilities and debts. Some states have exclusions and exemptions, as well. This then offers the taxable value of the estate.
Once you have that value, you have to apply the inheritance tax rate, which is usually graduated, meaning it increases as the value of the inheritance increases.
Key Differences: How They Apply to You
There are three main key differences between estate taxes and inheritance taxes. As noted, the first key difference is who is responsible for paying the tax. With estate tax, the decedent’s estate is the one responsible, while for inheritance tax, the person who receives the inheritance is responsible.
Another difference is where the taxes are paid. Federal estate taxes are paid to the federal government, while inheritance taxes are paid to the states that require them.
The final difference is that not all states require an inheritance tax, but federal estate taxes apply throughout the country.
Estate Planning for Minimizing Tax Liabilities
It’s not always possible to avoid inheritance taxes, but estate planning strategies like forming trusts, gifting assets before death, and taking advantage of state exemptions can all be crucial. These methods help to distribute assets more tax-efficiently.
Because estate taxes depend on the value of the assets, working with a lawyer who focuses on estate planning is essential. Offering gifts, choosing marital transfers, forming irrevocable life insurance trusts, and forming a family-limited partnership are all options if your estate is large enough to require federal estate taxation.
Working With a Lawyer to Protect Your Assets
It’s essential to work with a lawyer with experience in estate planning if you want to protect your legacy for your beneficiaries. The right lawyer will be able to guide you on the best strategies so you can minimize the taxes you pay.
At Kallio Law Firm we offer estate planning services you can depend on. We work closely with all of our clients to help provide the results you need. Contact Kallio Law Firm today to speak with an estate planning lawyer.
