One of the saddest things I have to handle in my job is when a client’s relative passes away. They have to file a tax return for the deceased, close the estate, redeem insurance policies, and deal with a lot of unfinished business, all while grieving. Those are difficult days for everyone involved. But the best part? That is when they look at me with teary eyes and ask, “How am I going to pay the inheritance tax?” and I answer: “You don’t have to!”
What is Inheritance Tax?
Inheritance tax is called estate tax by the IRS, and it is a transfer tax. A transfer tax is when you move assets from one person to another and the government takes a slice. Why? The original idea was to prevent an excess of generational wealth. When wealthy people die, a portion of their wealth goes to the community.
So, what is wealthy? That changes from year to year. The lowest amount I have seen in one million and the highest I have seen is currently fifteen million. But how is this measured? It is based on the size of your estate.
What is an Estate?
When you die, all your money and possessions become your estate. Your estate also includes all the debts you owed when you died. Whoever is in charge of your estate after you die is required to pay all your bills with whatever money you have.
If you had a car loan and not enough to pay it off, the car is sold. If you had a mortgage on your home and not enough cash to pay it off, the house is sold. Your credit cards need to be paid. Your phone bill, utilities, and everything needs to be paid off before anyone inherits anything. If you do not have enough to pay your bills, your estate is bankrupt.
On the other hand, if the bills are paid and there is money left over, you have an estate and the money goes to your heirs. If the bills are paid and there is a few million left over, then the estate needs to pay estate tax before any money goes to the heirs.
Who Pays Estate Tax?
Estate tax is paid by the estate. If you have an estate with enough wealth to owe estate tax, probate court is already involved and overseeing the bill payments and valuation of your property. They will be sure to have the estate tax paid before anyone inherits a dime. The government will get their slice first, and paying the tax will be another step of the executor paying the bills and settling the estate.
Inheritance is not Income
If your loved one dies and you are getting an inheritance, it comes to you tax paid. It is NOT income to you, it does not go on your tax forms or increase your income, and you do not pay the inheritance tax (estate tax). That is all paid by the estate before it comes to you.
So, as you deal with your grief and loss, you do not have to worry about paying taxes on any inheritance checks or being in a higher tax bracket. Inheritance tax is a transfer tax and is excluded from income tax.
And unless your relative left you a LOT of money, no tax is usually due.