Explanation of Inheritance and Estate Tax

Taxes in the United States become more complex with each passing year and, unfortunately, when you die, it's no different. If you have had someone close to you pass away, you are most likely familiar with the intricacies of post-death taxes. Here's an overview of these taxes and how they affect the executors and beneficiaries of an estate.

The terms "inheritance tax" and "estate tax" are frequently used interchangeably, but do have slightly different meanings. Inheritance tax is levied on the beneficiaries of estate assets whereas estate tax is levied upon the person who has died before the assets are distributed. The US federal system provides only for an estate tax whereas individual states can levy either an inheritance or an estate tax. The assets being taxed are the same in both cases. It is simply who pays the tax that changes.

US federal estate tax refers to a federal tax that is levied on the taxable estate. Your estate is determined by the fair market value of all of the assets you own at the time of your death. Your assets could include cash, stocks, bonds, real estate, trust assets, annuities, business interests and other property. This is your Gross Estate. From that, you are allowed certain deductions, mainly for any debt, like a mortgage, attached to the gross estate assets. You may also get deductions for property that transfers to your spouse or a qualified charity upon your death. Once these deductions have been factored in, you are left with your Taxable Estate. The estate tax is levied on this Taxable Estate. There is some tax relief for estates in the form of the Estate Tax Credit which is currently $2 million. That means that there is no tax payable on the first two million dollars of taxable estate assets and the tax only kicks in on amounts higher than that. Taxable estates under this $2 million threshold do not have to file an estate return. This is good news for most American families that have only modest wealth to pass on to the next generation. Therefore the tax is levied on less than the richest 2% of the American population.