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What is the Difference between Death Tax, Estate Tax and Inheritance Tax


Dear Advisor:


I am interested in finding information regarding inheritance tax and how it works. I would also like to know if death tax and inheritance tax are two different things. If you have any information regarding this and estate planning, I would be greatly interested. I have been a subscriber to your monthly newsletter for a couple of years and find it is very informative. I would appreciate any information you may have.

The phrase 'death tax' became popular during the political debates in recent years. There really isn't any such thing. (Even the IRS would have trouble collecting tax from someone who is dead!) It actually refers to the federal estate tax, which due to large exemptions, applies to less than 5% of the people in the country. However, many constituencies, including family businesses, are threatened by the estate tax. It sounds really stupid and nasty to tax people just because they died. Politicians and lobbyists found that using the phrase 'death tax' rallied the general population around the idea of reducing or repealing that offensive tax. It is one of the few instances that I have seen in which people who could never expect to be subject to a tax (because they are unlikely ever to be rich enough) rallied behind politicians to eliminate it.

Technically, the federal 'estate tax' is levied on the estate of a deceased person before any of the property is transferred to the heirs. On the other hand, most states assess an 'inheritance tax,' which is technically a tax on the individuals who receive property from an estate. That is a distinction that only interests constitutional scholars. As a practical matter, the estate pays both the federal and state taxes. Both of those taxes are based on the values of the assets owned (or deemed owned under a variety of rules) at death, less liabilities, and further reduced by an array of deductions and exemptions.

The estate tax was enacted in the early 20th century. It took the federal government a few years to discover that people could circumvent the tax by giving property away before they died. To prevent that, the government enacted a gift tax. It took the government about 60 years after that to figure out that really wealthy people could make gifts or bequests at death to grandchildren and therefore only pay one gift or estate tax as compared to paying two of those taxes if they gave the property to their children, who would later gave it to the grandchildren. So, in the mid-1980s, Congress enacted the 'generation skipping tax,' which effectively ensures that the government gets a gift or estate tax at each generation. The three taxes (gift, estate and generation skipping) are sometimes called 'transfer taxes,' although that term is not found in the law.

Typical estate planning is centered on taking the best advantage of the various deductions, exemptions and exclusions. More sophisticated planning can be used to reduce the value of assets, thereby the reducing the tax, without shifting that value outside of the family unit.

I don't have a concise, layperson's explanation that covers the overall topic, although there is probably more than you might ever want that is available on a piecemeal basis. For example, I searched for 'estate tax' in and found numerous links containing good information.

The toughest issue for you will be sorting out which planning techniques make the most sense for you/your family, based upon your specific objectives, needs and assets. After you do some reading, I suggest that you seek an experienced accountant or lawyer to help you in that regard.

Of course, keep reading The Family Business Advisor, which frequently contains articles about estate tax planning and related matters. Thanks for being a subscriber.

By Ross Nager, CPA and FBA Contributor




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