Wealth Transfer Taxes: What is an inheritance tax?
An inheritance tax is a type of wealth transfer tax that applies to the amount of gifts and bequests a taxpayer receives. It differs from an estate tax and gift tax in that the tax rate depends on the amount of gifts and bequests the taxpayer receives rather than on how much the donor gives or bequeaths. Unlike estate and gift taxes, a progressive inheritance tax gives donors an incentive to spread their wealth more broadly, because each of any number of recipients can claim an exemption and take advantage of the progressive tax rates, thus reducing their effective tax rate. Currently the United States has no federal inheritance tax, but several states do.
- The economic burden of all wealth transfer taxes falls predominantly on recipients and not donors, because the former tend to receive a smaller pre-tax inheritance than they would without the tax. However, the burden on individual recipients varies widely depending on whether the tax is an inheritance tax or an estate and gift tax. For example, if the 2009 estate tax were replaced on a revenue-neutral basis with an inheritance tax, the average tax rate would be much lower on heirs of smaller inheritances, and much higher on heirs of the largest inheritances. Under one option, the tax burden on heirs inheriting less than $500,000 would fall by $42,000, while that on heirs inheriting more than $50 million would rise by $5.3 million (see figure 1).
- Inheritance taxes come in three principal forms. An accessions tax applies to the amount an individual receives by bequest or gift over his or her lifetime. An annual inheritance tax applies to the gifts and bequests a person receives in a given year. An inclusion tax counts gifts and bequests as income and taxes them under the income tax; thus the tax rate depends on both the size of the gift or bequest and the recipient’s other income. An inclusion tax could be combined with either of the other types of inheritance taxes into one tax to take advantage of the strengths of each.
- Most countries rely on inheritance taxes rather than on estate and gift taxes. More than half of a group of thirty-four industrialized countries (see figure 2) have an annual inheritance tax; a few use accessions and inclusion taxes. Only three of the countries besides the United States have estate taxes. The past several decades have seen a shift away from estate taxes: Canada, Australia, and New Zealand repealed their estate taxes, and Ireland replaced its estate tax with an inheritance tax.
- Some commentators believe that inheritance taxes are simpler to administer than estate taxes, because they may curtail strategies used to avoid estate taxes, such as moving assets into complicated trusts that falsely suggest that a decedent’s estate will go to a person or entity exempt from the tax. Others believe that estate taxes are simpler because they require less recordkeeping.
- Because decedents typically leave bequests to multiple heirs, under one inheritance tax proposal, the number of heirs that would have to file inheritance tax returns would be roughly twice the number of estates that now must file estate tax returns. But that same proposal would roughly cut in half the number of heirs burdened, relative to the estate and gift tax, because small inheritances would not be taxed.