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In this blog post, we discuss the difference between estate tax and inheritance tax for Ohioans. Ohio residents preparing their estate plans frequently have questions about tax implications as they are choosing estate planning documents. The so-called “death taxes” – estate tax and inheritance tax – are often particular areas of concern. Ohio does not impose either tax, but some Ohio residents’ estates may be subject to the federal estate tax, and there are a few specific situations in which an Ohio resident’s beneficiary might be asked to pay inheritance tax in another state. Different factors affect tax liability for estate vs. inheritance taxes, so it is important to develop a clear understanding of the considerations involved.
Individuals preparing their estate plans in hopes of ensuring financial security for the loved ones they leave behind are understandably often concerned about the tax implications of their estate planning designs. Fortunately, in many cases these concerns can be allayed with a combination of appropriate estate planning tools and the information needed to use them effectively.
The two main taxes individuals ask about as they review the tax implications of their estate plans are estate and inheritance taxes. Both the Internal Revenue Service (IRS) and all states that employ an estate tax also employ a “threshold” exemption based on the total value of the decedent’s taxable estate, meaning that estates whose total value when calculated according to the statutory requirements is less than the threshold (typically updated on a yearly basis to account for current economic conditions) are considered exempt and will not owe estate tax, although depending on the decedent’s income and withholdings in their final year the estate may still owe an income tax payment when the executor files the decedent’s final income tax return.
The assets included in the calculations made to determine the size of the taxable estate are themselves subject to a number of exemptions, as described by the IRS, with the result that a substantial portion of estates, even those left by high-net-worth individuals, ultimately fall beneath the federal exemption level, and are thus exempt from the federal estate tax, according to the Center on Budget and Policy Priorities. An experienced estate planning attorney with Rhodium Law may be able to help you evaluate the factors likely to be used in calculating the size of your taxable estate and offer a tailored perspective as you consider the tax implications of your current estate planning design.
The fact that estate tax is paid out of the estate itself, before any property is distributed to the decedent’s beneficiaries in accordance with the wishes the individual has set out in their Last Will and Testament, while inheritance tax is typically paid by the heir or beneficiary who receives property from a decedent’s estate, out of the value of the property received, can easily lead to a misconception that an estate tax is a tax on wealth itself – a way of extracting one last drop from the defenseless deceased – whereas an inheritance tax is a tax on grief, a penalty paid by the living to keep them from benefitting too greatly from the loss of their loved one. Such feelings are especially understandable when one considers the circumstances of deep suffering in which the latter tax, in particular, is likely to be paid – however, a closer look at how these taxes are defined in the jurisdictions that apply them may suggest an alternate perspective, with some estate planning tax implications.
Both estate taxes and inheritance taxes are forms of wealth transfer taxes – and in both cases, the easiest way to understand how the specific tax works and when it is likely to apply may be to think of the inheritance tax or the estate tax as a tax on the transfer of property on the circumstance of the owner’s death and therefore outside any of the mechanisms – such as sales taxes and capital gains taxes – that are typically applied to assets when transferred by the living. The IRS specifically defines an estate tax as a tax “on [the person’s] right to transfer property at [their] death.”
Since there is no federal inheritance tax, the IRS does not provide comparable guidance for understanding the basis of inheritance taxes. Generally speaking, the concept of a transfer continues to be significant, but there is some variation among the states that impose an inheritance tax regarding how responsibility for the transfer, and the tax, is assigned. For instance, most states with inheritance tax make payment of whatever tax is levied the responsibility of the party receiving the inheritance – but the Register of Wills for Montgomery County, Pennsylvania explains that in that state the responsibility for remittance falls first on the executor of the estate, and the heir or beneficiary is required to file a return and remit the appropriate tax only if there is no executor nor court-approved administrator for the estate. The Kentucky Department of Revenue describes that state’s inheritance tax as “a tax on the beneficiary’s right to receive property from a deceased person,” presenting essentially the obverse face of the federal estate tax; the New Jersey Treasury, meanwhile, avoids attributing its inheritance tax to the rights of either the beneficiary or the decedent, and instead explains that the state “may impose a tax on this ‘transfer’ of ownership” – taxing the transfer itself, irrespective of whose right is exercised in making it.
Despite the variability in how the transfer is framed, as well as in how, and by whom the tax assessed should be paid, what all of these states’ laws governing inheritance taxes have in common is the central premise of assessing a tax at the transfer of property, in the absence of a transaction (such as an exchange of money for goods or services, or the realization of capital gains on appreciated assets). Understanding estate and inheritance taxes as a subcategory of wealth transfer taxes, in which tax implications are occasioned by the transfer of property, and assessed on the amount transferred – either collectively, on the sum of all property to be transferred, in the case of an estate tax, or separately, on the amount transferred to individual beneficiaries, for an inheritance tax – can also help to clarify why inheritance tax is typically assessed based on the tax laws of the state in which the decedent was living at the time of their death, rather than on laws of the state in which any individual heir or beneficiary is living when they receive the property left to them: In each case, the tax is assessed in the location where the transfer is initiated.
The same underlying logic also helps to explain some of the most commonly available inheritance tax exemptions, many of which are based not on the size of the bequest, but on the degree of kinship between the decedent and the beneficiary. Although the specific division and terminological frameworks used for determining inheritance tax exemptions do vary between states, in general the nearer the degree of kinship between decedent and heir or beneficiary, the greater the likelihood of exemption and the lower the rate of any inheritance tax levied.
In order to properly assess the implications of estate vs. inheritance tax for their own estate planning designs, individuals will need to determine whether estate vs. inheritance tax is more likely to apply in their unique circumstances. For estate tax, this can be a “simple” (but in reality often quite complex) matter of determining which assets will likely be included in computing the size of their taxable estate, as it exists at the time of their death (a process that will necessarily involve an element of prediction). For inheritance tax, however, a resident of an estate with an inheritance tax must perform separate calculations for each beneficiary to whom they consider leaving a gift in their will.
Many individuals’ estates will qualify for the federal estate tax exemption. However, Ohioans who anticipate that their estates may be subject to the federal estate tax may also be disproportionately likely to find that some of their beneficiaries will need to pay an inheritance tax on any gifts left to them in the Ohio resident’s will, owing to particularities of inheritance tax laws in the states that do have impose this type of tax. This specific estate planning risk arises from a provision of inheritance tax laws in some states, such as Kentucky and Pennsylvania, that allow for the state inheritance tax to be assessed on the transfer of property located within the borders of the state from a non-resident owner to an heir or beneficiary when the relationship between decedent and beneficiary is one that would be taxable under state inheritance tax laws if the decedent had been domiciled in the state.
Presuming that the tax is assessed pursuant to the laws of the jurisdiction in which the transfer is initiated, the following sample scenarios may help to clarify some of the differences in how inheritance tax vs. estate tax may be assessed:
Given that individuals with high net worth are disproportionately likely to own property in multiple states, Ohioans who do own property in a state that assesses inheritance tax may wish to carefully review their options for transferring that property via an alternate method, such as an irrevocable trust or life insurance policy, in order to limit the chances that the gifts they leave loved ones in their wills may be subject to both estate and inheritance taxes.
If you are preparing your estate plan as an Ohio resident, and you have concerns about the potential for the legacy you leave your loved ones to be impacted by federal estate tax or by inheritance tax levied in another state, consider speaking with an experienced Ohio estate planning attorney who can offer you perspective and help you develop an estate plan to secure your peace of mind. The tax implications of estate vs. inheritance taxes can vary widely, especially in terms of how eligibility for exemptions may be determined.
There are also significant differences in who may be responsible for paying inheritance tax vs. estate tax which could affect which estate planning design choices make the most sense for an individual situation, so call (216) 699-8145 today to request a consultation with the estate planning team at Rhodium Law.
