Many people know that estate taxes and inheritance taxes have something to do with someone passing away, but beyond that, the terms seem to be used interchangeably; however, there's a difference between these two terms, that can be an important part of your estate planning strategies.
An estate tax is paid out of the proceeds of the estate itself. The value of property in the estate is subtracted by the number of liabilities for the net amount that can be taxed.
Because the tax is paid by the estate, it is reduced from the value of the estate before any individual beneficiary gets his or her allocation (inheritance) from the estate.
An inheritance tax is a tax imposed on the individuals who actually inherit property. The individual is taxed on the value of the property he or she inherits, just as someone would pay a tax anytime income or profit were realized for any other reason; however, in some cases, a will or an estate will provide extra money for beneficiaries, to help them pay those taxes.
Estate taxes vary from state to state, and there is a federal estate tax as well. Luckily, when it comes to federal estate taxes, only estates that are valued at over $11.7 million owe the tax.
That number does change, and sometimes very frequently, so check with your estate attorney about whether your estate will have to pay the tax. Additionally, states can impose their own estate taxes which may be less than the federal threshold.
Also, in some cases, certain property in the estate can be exempted which lowers the value of the estate. This means that you can often lower the value of your estate to a level that may be below what the federal or state estate taxes may be.
Fortunately, Illinois does not have an individual inheritance tax. There is no federal inheritance tax. In many states with the tax, surviving spouses are exempt, and many will also exempt surviving children from paying the tax.
Usually, the more distant the relative who inherits property, the higher the tax can be. Many states that impose an inheritance tax also allow for exemptions, lowering the value of what is inherited.
The states with an inheritance tax currently include Maryland, Kentucky, Nebraska, New Jersey, and Pennsylvania.
Why should you care if you don’t live in those states? Because if your beneficiaries do, they may be liable for the inheritance tax, even though you lived in, and passed away in, Illinois. That means that out-of-state beneficiaries should have a plan to deal with inheritance taxes if they live in one of those states.
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