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We Don’t Owe Estate Tax So What the Heck is Inheritance Tax?

I got a call from Joe last week. His brother Jim died 5 months ago.  Jim had never married and had no children, leaving his estate of assets totaling $150,000 to Joe.  Everything seemed so simple.  There was no need to pay taxes, or so he thought, because there is no federal estate tax this year and New Jersey estate tax is only owed on estates greater than $675,000.  So why was Joe’s friend telling him he may have to pay taxes?

What Joe was talking about is inheritance tax.  Only a handful of states have it and New Jersey is one of them.  Inheritance tax works differently than estate tax, which is based on the size of the estate.  Inheritance tax, on the other hand, is based on the relationship of the heirs to the decedent (person who died).  Parents, grandparents, children, grandchildren, spouses and domestic partners are exempt from the tax.  So are stepchildren, but not stepgrandchildren.  Siblings, sons in-law and daughters in-law pay tax at one rate and other more distant relatives and non-relatives pay tax at another rate.

Inheritance tax is due 8 months after death, one month before the estate tax is due.  In cases where both estate and inheritance tax are due, the total combined tax is not greater than the larger of the 2 taxes.  In essence, if inheritance tax is due then that payment acts as a credit towards the estate tax.

Joe, like most people, was unaware of inheritance tax.  It is typically owed on estates where there are no spouses or children.  In his case, the tax totals about $13,000 and if not paid, carries 10% per year interest rate.  There are other quirks in terms of what is taxed and what isn’t.  For example, life insurance isn’t subject to the tax if you’ve left it to named beneficiaries.  However, if those people all have died, for example, and the insurance is left to the estate, then it is taxed.  However, the life insurance is subject to estate tax .  It is easy to get tripped up by which assets are taxed for inheritance, and which for estate tax purposes.

The point is that each estate has to be looked at individually.  Just because your friend or neighbor didn’t have to pay inheritance tax doesn’t mean you don’t have to.  I explained to Joe that we still have time to complete the return and pay the tax on time.  The last thing he wants is the state coming after him for unpaid tax.