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What's the difference between estate taxes and inheritance taxes?

Wednesday, March 23, 2011

Different jurisdictions use different terms for the taxes they levy when an individual dies so it isn't possible to make an absolute distinction between estate taxes and inheritance taxes. However, the tax that the federal government levies on larger estates is always called the "Federal Estate Tax".  Beyond that, the most valid generalizations are as follows:

-    Estate taxes are taxes levied on the value of the assets that were owned by a deceased individual. They are usually paid out of the assets of the estate before the estate is distributed. A number of states levy estate taxes separate from and in addition to the federal estate tax. The federal estate tax, levied only if the estate is large enough, is the largest tax levied.  (For more information on estate taxes and how they can be reduced or avoided see our blog entitled ESTATE TAXES.) 

-    Inheritance taxes are taxes levied on the portion of an estate inherited by a specific individual.  These taxes are the responsibility of the individual who inherits and are usually paid out of that individual's inherited assets.  The federal government does not levy an inheritance tax. Relatively few states levy inheritance taxes.

Here’s the current federal estate tax table in which TM = taxable e
state = gross estate less exclusions and "m" in this table = million 

2008-1st $2 m of TE excluded, balance @ 45%

2009-1st $3.5m of TE excluded,balance @ 45%

2010-The executor has options – see below

2011-1st $5 m of TE excluded, balance @ 35%

2012-1st $5 m of TE excluded, balance @ 35%


For both 2011 and 2012 (and 2010 if the 2011 option is selected) the $5 million exclusion is portable, meaning if a spouse doesn’t use all of his or her $5 million exclusion the survivor can use some or all of it.  Portability is limited to spouses.


OPTIONS - for estates of 2010 decedents:

1) The executor can elect to accept the rules in effect prior to the 2010 Tax Relief Act.  This election must be made no later than September 19, 2011.  These new rules provide a $5 million estate tax exemption, a 35% estate tax rate and a full stepped-up basis for most assets included in the gross estate, or

2) The executor may (do nothing and) choose to accept the federal estate tax rules for 2010 Estates which include no federal estate tax but also no stepped-up basis for assets.


Note: There are exceptions to basis rules:

If the 2010 rules are selected the heir can choose to take a step-up in basis for $1.3 million of the property. For any amount inherited over $1.3 million, the heir's basis will be the smaller of the deceased owner's basis or the date-of-death-market value. The basis of property passing to a surviving spouse can be increased by an additional $3 million for a total basis increase of $4.3 million.  Basis of property given to the decedent by someone other than his/her spouse within 3 years of death cannot be increased.  


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