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September 20, 2022
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Estate and inheritance taxes, and those that avoid paying them

Taxes are notoriously difficult to understand and it does not help that U.S. tax laws are heavily influenced by lobbyists or political donations – and those who can afford to pay for such influence.

Take for example, the 2017 Tax Cut and Jobs Act. On the surface, it was promoted as a tax reduction for the middle class, but if you read into the text, it clearly does a lot more to benefit the wealthy. Included in the bill were big changes to reduce estate and inheritance taxes – taxes that only 1-2% of the population even pay.

Business journalists can apply their savvy to uncovering such boondoggles, resulting in some illuminating stories for readers that serve a key goal of financial journalism: leveling the playing field. Here is what to know about these two taxes, which might sound equivalent but are quite different.

Estate tax

A person’s estate consists of cash, real estate, insurance, business interests, and any other assets they own. When a person dies, anything they chose to transfer to another individual is potentially subject to an estate tax by the federal government. This tax is generally paid by the estate itself.

Since the adoption of the modern estate tax in 1916, the number of taxable estates hovered around 1-2% of the adult population for almost a century. The only exception was between 1954 and 1976 when that percentage slowly crept up to 8%, due to a variety of reasons. The Tax Reform Act in 1976 and the subsequent Economic Recovery Tax Act of 1981 made substantial changes to ensure these taxes would impact the fewest number of estates. Currently, only 0.2% of people will be subject to such taxes as the exemption amount was increased from $650,000 to $5.49 million in 2013, thanks to the American Taxpayer Relief Act.

Only a handful of states impose their own estate taxes and several have recently changed their laws. Delaware repealed its estate tax entirely in 2018, New Jersey started phasing theirs out in 2017, and Connecticut and Vermont have raised their exemptions to more closely match the federal level.

Inheritance tax

This is a tax imposed by the state on the recipient of the inheritance rather than the estate of the deceased. This is actually a rather uncommon tax in the U.S., where only six states have relevant tax laws and there is no inheritance tax at the federal level. This practice is much more common dating back to the Roman Empire when taxes were used to pay for soldiers’ pensions.

Each state has its own rules, but they all have to follow the same general premise that the closer you are to the deceased, the less you will be taxed. For example, in Pennsylvania spouses are completely exempt from an inheritance tax, but anyone else is set up in a tier system. Children of the deceased pay a 4.5% tax, siblings pay 12%, and anyone else that receives an inheritance, except a charity or other institution exempt from taxes, would pay 15%.

In Nebraska, residents pay county taxes on land or property they inherit. The state just recently changed its laws to reduce inheritance taxes. Currently, for immediate family the first $40,000 is exempt, but beginning January 1, 2023, that exempt amount is now $100,000. Any additional amount is taxed at a 1% rate.

The other four states with inheritance tax laws are Iowa, Kentucky, Maryland, and New Jersey.

Ways the rich avoid paying these taxes

In addition to being able to influence legislation, the wealthy have other strategies – unavailable to ordinary citizens – to avoid estate and inheritance taxes. Here are some ways they do that:

Give gifts to family: You can now give up to $16,000* to any person each year, tax-free and there is no limit to how many people you can gift money to. There is a lifetime limit of $12.06 million*, otherwise, you are subject to a gift tax.

Trusts: There are several trust structures that allow people to transfer their wealth away from their estate to avoid taxes. This includes irrevocable life insurance trusts, charitable lead trusts, charitable remainder trusts, and qualified personal residence trusts.

Family limited partnerships: The biggest assets a person owns are businesses and properties. A person can set up a general partnership and make their heirs limited partners, so as far as the IRS is concerned, those assets are not a part of the estate.

*These current levels were established by the 2017 Tax Cuts and Jobs Act, which if not renewed will expire in 2025, returning the amounts to pre-2018 levels of around 5.5 million over a lifetime adjusted for inflation.

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