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Differences Between Estate Taxes and Inheritance Taxes

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September 19  |  Estate Tax, Inheritance Tax  |   admin

Dealing with the loss of a loved one is no doubt an emotionally taxing experience for all of us. Important concerns surface when confronted with resolving issues regarding the last wishes of the deceased and necessary final expenses. For instance, what will become of the residence where they lived? Also, what specifications were made in their will regarding who receives financial sums or possessions? Answering these questions may require the outside assistance of a professional well-versed in related legal procedures and any required taxes that may apply in these situations, such as clarifying the way that estate and inheritance taxes differ.

What is estate tax?

Regardless of whether your estate is inherited by means of a formal will or not, heirs of any deceased taxpayer are responsible for paying a federal estate tax on assets that comprised the residence of that individual. A number of states impose taxes on personal assets as well. For states that impose an estate tax, tax liability increases. As of 2011, estate tax applies to any estate starting with a value of $1 million, although congress is expected to reinstate the previous higher taxable estate value starting at $3.5 million in the near future. Because of the monetary value cut off limit, estate tax does not apply to a number of Americans. Notably, dual-income families should consider if their combined earnings will be cause for an estate tax as more than half of all estates must be paid in federal estate taxes once they reach a particular value.

Federal law

Obtaining direction regarding federal laws governing estate taxes can result in greater personal power over financial outcomes. Estate planning is a proactive approach that can prove very beneficial in arranging for the future distribution of assets once you pass away. It is important to familiarize yourself with government stipulations in order to best protect your assets. Be aware that a federal gift tax applies to keep people from giving away their property before they pass away. In addition, individuals are entitled to own half of a spouse’s estate free of tax as each is considered an equal estate owner. Estates are typically transferred from the last surviving parent to their descendants. Time is an important factor when filing federal estate tax as it must take place within nine months of the individual’s death. However, in cases where an estate needs more time to cover tax liabilities, an extension may be granted.

Tax rates

The estate tax rate scale of taxation does not apply to lower end estates valued at up to $1 million. Estates worth more than this amount are subject to a tax of 55 percent of the estimated value. Overall value is determined through combining assets, including real estate, monetary holdings, investments, annuities and more. Through the gift tax code, up to $13,000 can be gifted to any number of beneficiaries during your lifetime on an annual basis free of tax. This number is doubled for married couples. Gift allowances can also be used to shrink the value of an estate so that estate taxes will no longer apply. In view of this fact, the subject of estate tax has created controversy in terms of how it affects the wealthy, their inheritance, and their incentive to stay in the workforce.

Decreasing estate taxes

Many enforced financial liabilities that occur as a result of estate tax can be overcome with the creation of an irrevocable trust.  An irrevocable trust is an agreement between yourself, your bank and your beneficiaries that is most often permanent in nature. When formulating the trust, you relinquish control over any property included in the trust in order to gain beneficial tax advantages. One clear advantage is that of decreased estate taxes and increased savings passed on to your loved ones in the future.

What is inheritance tax?

Beneficiaries of the deceased should also determine whether an inheritance tax will apply to them. The IRS defines an inheritance as the act of leaving property to a specified person through their last will and testament. In many cases, the term inheritance tax is not properly or easily understood. Even tax professionals may refer to such a tax as an estate tax. To avoid personal tax conflicts, it’s crucial to know exactly what an inheritance tax is. This is a tax collected as a result of a person inheriting property or money from one who is deceased. On the other hand, estate tax is imposed on the fair market value of the estate and results from that estate. Unlike estate taxes, which are imposed by the state on the gross appraised value of the property, inheritance taxes are assessed based solely on the part of the estate that the beneficiary receives.

Tax rates

Inheritance tax rates fluctuate based on specific facts, such as the fair market value of your inheritance. This figure will determine how much can be excluded from taxation as well as the particular tax rate that will affect the remaining value. Depending on where you live, you may be liable for state and federal inheritance taxes. These tax rates are progressive and relate directly to beneficiary earnings. State inheritance tax rates may not apply at either exact or progressive rates, depending on the state in which you live. States that do collect inheritance taxes may impose various tax rates on your inheritance depending on your relationship with the deceased. Spouses, siblings, children or parents might be deemed fully exempt from an inheritance tax or pay very low rates. If you are a beneficiary who is not related or only distantly related to your benefactor, the highest inheritance tax rates will usually apply.

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