You have taken steps to protect your estate long after you’re gone, or you are considering beginning the process of estate planning. No matter your situation, estate planning offers options for everybody.
What about the intricacies of estate planning, like the taxes involved? Yes, even after you’ve passed, if your estate assets surpass a certain federal or state threshold, the federal or state government wants a piece of the pie.
So, how do estate and inheritance taxes differ? Well, one major difference lies within tax calculations. Estate taxes are determined by adding up the value of all property owned by the deceased on the day of their death.
Inheritance taxes are determined by calculating the value of an inherited asset (bequest). Unless the deceased estate owner stipulated in their estate plan that the estate would cover the taxes of the inherited item, the beneficiary would have to pick up the tab by way of the gift amount of otherwise.
What are the other differences between estate and inheritance taxes?
Many states, including Colorado, do not carry an estate tax, and neither does the federal government. If your state does collect an estate tax, your estate must exceed the exception amount, say $1 million, for example, to incur taxes. So if your estate totaled $1.5 million, the $500,000 exceeding the $1 million exemption would fall subject to estate taxes by your selected state.
Federal estate taxes work the same way. The current estate tax exemption sits at $11.58 million per individual and $23.16 million per couple. As an example, let’s say Bill passed away with an estate totaling $7 million. His estate would not have to pay estate taxes because it falls below the $11.58 million threshold. If his state’s estate tax threshold were anything less than $7 million, his estate would fall subject to taxes at the cited amount.
Colorado does not collect an inheritance tax. On the other hand, if you live in Maryland, as of 2019, your state collected an estate and inheritance tax. For those that will have to pay inheritance taxes, consider that all states that collect this tax, exempt surviving spouses from having to pay. Four of the states that collect inheritance taxes – Iowa, Kentucky, Maryland and New Jersey – exempt children and grandchildren from having to pay bequest taxes as well.
Beneficiaries that are required to pay inheritance taxes, unless otherwise stipulated in the deceased owner’s estate, include siblings, nieces, nephews and friends.
As an example, your friend passed away and left you his vacation home, valued at $400,000. If the state inheritance is a modest 15%, you would owe $60,000 upon receipt of the home. As highlighted above, if the estate plan stipulated that the deceased person’s estate will cover the inheritance tax, you would not be liable for tax payments.
If you live in Colorado, you don’t need to worry about state estate of inheritance taxes but will need to aware of federal estate taxes if your estate exceeds the 11.58 million individual exemption or the $23.16 million couples exemption.