How an Estate Tax is Different from an Inheritance Tax

Most people only learn about the difference between these two taxes when they are creating an estate plan or settling an estate.

Depending on the state, heirs are surprised when they learn that their inheritance will be diminished by death taxes: an estate tax and sometimes an estate tax and an inheritance tax may take a bite out of their inheritance. According to in “Estate tax? Inheritance tax? A primer for NJ,” these are two different taxes category of death taxes. Every state is different.

The federal government imposes an estate tax, but not an inheritance tax. New Jersey, for example has both an estate tax and an inheritance tax in 2017. The state’s estate tax is scheduled for repeal next year, but the inheritance tax will still be on the books. There are other states with just an estate tax and others with only an inheritance tax. Finally, there are states with neither an estate tax nor an inheritance tax.

An estate tax imposed by the state makes it an expensive state in which to die. The estate tax is payable by a decedent’s estate and usually is derived from the fair market value of the decedent’s assets on the date of death. There are also some deductions that apply to reduce the taxable estate, like the unlimited marital and charitable deductions.

In 2017, the federal estate tax exemption is $5.49 million and the New Jersey estate tax exemption is $2 million. Therefore, in the Garden State, taxes will only apply, if the taxable estate exceeds these amounts, and the estate tax rate is applied to the taxable estate. The tax is paid on the decedent’s estate tax return. The federal rate is 40%, and the highest New Jersey estate tax rate is 16%, making for  a strong incentive to create an estate plan.

An inheritance tax applies a tax based on the relationship of the beneficiary to the decedent and the amount that the beneficiary receives.

There is no federal inheritance tax, and states like Pennsylvania don’t have an estate tax but do have an inheritance tax. New Jersey has both taxes, which are structured to effectively offset each another. The total tax paid is no greater than the greater of the separately calculated estate tax or inheritance tax.

An experienced estate planning attorney can help you understand what your estate tax and inheritance tax liabilities will be, and create an estate plan that will work best for you and your family. If are lucky enough to live in a state with no death taxes, you still need a will and an estate plan to ensure that your assets are distributed according to your wishes.

Reference: (February 7, 2017) “Estate tax? Inheritance tax? A primer for NJ.”