The term legacy tax refers to a type of tax imposed on a decedent’s estate, when the estate is passed on to beneficiaries through either a will or intestate succession. Legacy tax may also be referred to as collateral inheritance tax. Whereas death taxes are placed upon the estate itself, legacy tax must be paid by the people who receive property or assets from the estate.

Legacy taxes enable the government to tax the decedent’s estate due to the belief that receiving their property is not a right. Thus, the property is taxable, much like an excise tax, otherwise known as a luxury tax.

Federal laws do not generally govern legacy taxes. Rather, the laws that govern inheritance taxes are controlled by the state. As such, these laws may vary based on where the estate holder died, as well as where their will documents were created and executed. Legacy taxes differ from gift taxes mainly in regards to the status of the person giving the estate. In a legacy tax situation, the person giving the estate has died. When a gift tax is levied, the person giving the estate is still alive.

How Does a Legacy Tax Differ from an Inheritance Tax?

Although legacy taxes are also referred to as collateral inheritance tax, there are two significant differences. These are:

  • Who Receives the Property: When an inheritance tax is levied, the decedent gives their estate to a spouse, parent, or other family member. This is accomplished through either a will left by the decedent, or intestate succession if no such documents are found. Legacy taxes, on the other hand, are imposed when the decedent gives their property to someone who is not related to them. The recipient could be a friend, or a charity. Again, this accomplished either through a will or intestate succession; and
  • How the Tax is Paid: Inheritance taxes are paid out by the person who inherits the property. An example of this would be if a person receives property valued at $10,000 from their deceased parent. The person receiving the property is responsible for paying the appropriate taxes on that $10,000. Legacy taxes are paid out of the property being given to the recipient.
    • An example of this would be inheriting a piece of property from a friend that is valued at $10,000. The $10,000 would be discounted by appropriate taxes. What this means is that the recipient does not personally pay anything simply for having received the property. Thus, they will not be required to pay legacy taxes after receiving the property, although they may have other tax burdens from the inheritance.

How Are Inheritance Taxes Calculated? What Can be Done to Reduce Inheritance Taxes?

Because a legacy tax is also referred to a collateral inheritance tax, it is useful to look at how inheritance taxes are calculated. These taxes are generally calculated according to the amount or value of the property received by the beneficiary, in addition to the beneficiary’s relationship to the decedent.

When calculating an inheritance tax, the court may use the following factors:

  • Any outstanding debt left by the decedent;
  • Whether the decedent previously made certain transfer to charitable organizations;
  • Whether the decedent made transfers to their spouse; and
  • Whether the decedent claimed certain losses, such as losses related to investments or theft.

The calculation of inheritance taxes varies widely by state, with most states requiring that the estate have a minimum worth before any taxes are imposed on the estate. If these estate falls before a specific minimum value, inheritance taxes will not be required. Inheritance taxes can be a large financial burden on the property’s recipient, with the tax requirements often outweighing any actual benefit associated with transferring assets through estate distribution.

In order to reduce inheritance and estate taxes, some of the following options may be considered:

  • Transferring assets prior to death through financial and legal mechanisms, such as sale agreements, partnership arrangements, or gifts;
  • Purchasing life insurance for the estate holder in order to offset some costs associated with death and estate distribution;
  • Inquire about different inheritance and estate tax payment options; and/or
  • Create a family trust which sometimes allows for transfers to be made to family members at less than full value.

It is crucial that you do not avoid tax liability altogether. If you legally owe taxes, it is in your own best interest to pay them. It is important that you not try to evade taxes, as there are legal steps you may take to minimize tax liability that are not illegal.

Do I Need an Attorney for Legacy Taxes?

If you are planning for the distribution of your estate upon your death, or have received property from a decedent through their will or intestate succession, you should consult with a skilled and knowledgeable estate attorney in your area.

An experienced estate attorney can help you understand your state’s laws regarding the matter, as well as your rights and responsibilities. An attorney can also oversee your estate’s distribution or ensure that you are paying the correct taxes. Additionally, an attorney will represent you in court as needed.