Two types of taxes can be assessed against property that passes to your heirs after you die. They are: estate taxes and inheritance taxes. Estate taxes are further divided into two types, depending upon the taxing authority imposing the tax. Federal estate taxes are imposed by the U.S. government, while state estate taxes are imposed by various state governments.
1. Estate Taxes.
A. Federal Estate Taxes. The federal estate tax is a tax imposed by the federal government on property transferred to your heirs after your death. The fair market value of everything you own at the time of death is used to determine your “gross estate,” from which certain deductions are allowed, such as mortgages and other debts, estate administration expenses, property that passes to surviving spouses and qualified charities. The resulting amount is called the “taxable estate.” After the taxable estate is determined, the value of all lifetime taxable gifts is added and the federal estate tax is then computed. However, there is an amount, called the federal estate tax exemption, which passes free of federal estate taxes. The amount of the federal estate tax exemption has varied over the years. The federal estate tax exemption was $5,000,000 for 2010 and 2011 and is $5,120,000 for 2012, but is scheduled to decrease to $1,000,000 on January 1, 2013.
B. State Estate Taxes. Like the federal estate tax, state estate tax is also based on the value of the entire estate. However, state tax rates are much lower than federal tax rates. Notwithstanding the lower state estate tax rates, however, many smaller estates with assets valued at less than the federal estate tax exempt amount which do not owe any federal estate taxes do, in fact, owe state estate taxes. Whether an estate owes a state estate tax depends upon the residence of the deceased person, and the location and value of the property owned by the decedent. Today, the District of Columbia and a number of states impose a separate state estate tax: Connecticut, Delaware, Hawaii, Illinois, Maine, Maryland, Massachusetts, Minnesota, New Jersey, New York, North Carolina, Ohio (repealed for deaths as of January 1, 2013), Oregon, Rhode Island, Tennessee, Vermont, Washington and Wisconsin (repealed for deaths in 2008 through 2012). Under current law,New Jersey estates valued at more than $675,000 are subject to the New Jersey estate tax. The attached State Estate Tax and Exemption Chart lists each state’s estate tax exemption amount.
2. Inheritance Taxes.
Although the federal government does not impose any inheritance tax, a number of states impose an inheritance tax on beneficiaries who inherit property. An inheritance tax may be imposed in addition to the federal estate tax and any state estate tax. Unlike the taxes on estates discussed above, the amount of the inheritance tax imposed is not based upon the total value of the estate. Rather, the amount of inheritance tax due depends on how closely related you were to the person who died and left you an inheritance. For that reason, you may owe inheritance taxes even if your inheritance is small. The surviving spouse is exempt from inheritance tax in all states. Some states, like New Jersey, also do not tax the deceased person’s children. People who are more distantly related to the decedent, or who aren’t related at all, are taxed at higher rates. The inheritance tax rate in New Jersey varies between 0% for Class “A” beneficiaries, such as a spouse, domestic partner, or civil union partner, parent or grandparent, child and the like, to 16% for Class “C” and “D” beneficiaries, such as a brother or sister, spouse or civil union partner of the deceased person’s child, and friends.
3. Death Taxes.
The term “death tax” is a newly-coined term which, some believe, is used by critics of the estate tax system as a tactic to aid in efforts to repeal estate taxes. The term refers to any tax imposed on property transferred as a result of someone’s death, such as either an estate tax or an inheritance tax.