Who Pays Inheritance Tax?
The short answer is that the estate is responsible to pay Inheritance Tax out of the money the beneficiaries would have received. I need to explain what the words estate, inheritance tax and beneficiaries mean in this context.
When a person is alive, they own assets and need to pay their bills. When a person dies, their estate owns their assets and is responsible to pay all of their bills. An estate is a legal entity opened by a probate court which allows the Personal Representative (aka Executor), to collect the assets and pay the bills of the deceased.
No one gets a penny of their inheritance until all the assets are collected and all of their bills are paid.
Inheritance Tax is one type of death tax. Inheritance tax is a tax imposed by one of the 50 states on the assets owned by the deceased at the time of their death. Generally, this tax is calculated based on the beneficiaries’ relationship to the deceased. The payment should be made out of the estate, not by the beneficiary. The closer the relationship, the lower the tax. The reason the estate should pay the tax is because if the beneficiary doesn’t pay, the state will go after the Personal Representative.
Arizona does not have inheritance tax. That means, whatever assets you own in Arizona are not taxed by the State of Arizona when you die. But if you die in Arizona and own real estate in Iowa, for example, your estate will have to pay inheritance tax on the value of the real estate located in Iowa.
In some state that don’t have inheritance tax, there can be an additional income tax, capital gains, on death. This tax can be very expensive.
In Arizona, we use the term Personal Representative, which is gender neutral. Elsewhere, they call the same job an Executor (man) or Executrix (woman). A Personal Representative administers the estate by collecting assets, paying bills, and giving out as inheritance what’s left (if anything) to the beneficiaries. Sometimes there is nothing left.
In summary, a Personal Representative is the person who does all the work for an estate and takes all the flack over the 2 years a probate usually takes to administrate. I’ve seen complex probates take even longer by decades. Beneficiaries get impatient and then don’t want to ‘lose’ any of the money they haven’t received yet.
Personal Representative vs. Beneficiary
The difference between a Personal Representative and a beneficiary is that a personal representative has the job of administering the estate. The beneficiary is an individual entitled to the assets of the estate, if any. A Personal Representative can also be a beneficiary. This can be a conflict of interest but happens most the time because no one else would do the job.
Estate Planning Helps
Estate Planning helps families by allowing families to not have to go through probate and to reduce or eliminate death taxes. Death taxes are very complicated and impact each family member differently. You can’t sort out death taxes without a professional.
A Will is Not Enough
Some people think they have completed their estate planning by filling out a free will template online. A will is just a key into the probate court. If you want to subject your family to probate, you can do a will. They will be there without a will anyways.
Will based planning cannot help reduce death taxes. Also, probate can be a nightmare. It’s important to remember that probate must be completed in Arizona within two years of the date of death. That means people are going through probate while grieving. Typically, people are known to make bad decisions while they are grieving.
I recommend trust-based estate planning to the vast majority of my clients. Trusts are the best way to reduce or eliminate death taxes. A Trust is like a box which owns your assets before you die. The Trust also owns your assets after you die. Your death does not require a probate estate to be opened and a well written trust sometimes eliminates the tax. A Trust can hold real estate from any state in the United States. An American Trust cannot own real estate located in Mexico or in any other country.
Other Estate Planning Documents
A good estate planning lawyer will also draft several other documents for you that are not related to death taxes. These will help you manage your assets while you are alive and healthy or if you become seriously ill. Assets like IRA’s and 401(k)s cannot go in a Trust. Your estate planning attorney will help you control these assets as well.
Death taxes are complicated. If you want to help your family by reducing or eliminating these taxes, go to someone qualified to help you. If you are already involved in a probate administration, it’s not too late to get the help you need.