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 What Is A Legacy Tax? How Does It Differ From A Gift Tax?

The term legacy tax refers to a specific type of tax that is imposed on a decedent’s estate. Legacy tax is imposed when the estate is passed on to beneficiaries through either a will or intestate succession and may also be referred to as collateral inheritance tax. While death taxes are placed upon the estate itself, the legacy tax must be paid by the people who receive property or assets from the estate; meaning, legacy tax must be paid by the beneficiaries, and not the estate.

Legacy taxes allow the government to tax the decedent’s estate due to the belief that receiving their property is not a right. What this means is that the property is taxable, similar to an excise tax which is also known as a luxury tax.

Generally speaking, federal laws do not govern legacy taxes. Rather, the laws that govern inheritance taxes are controlled by the state. Because of this, these laws may vary considerably based on where the estate holder died, as well as the state in which their will documents were created and executed.

Legacy taxes largely differ from gift taxes in terms of the status of the person who is giving the estate. In circumstances involving a legacy tax, the person who is giving the estate has died. Alternatively, when a gift tax is levied, the person who is giving the estate is still alive.

To further differentiate the two, a gift tax is the federal tax that is placed on gifts paid by the donor. The federal tax gift is intended to prevent people from avoiding the federal estate tax by giving away all of their money before they die. This tax applies whether or not the donor intends the transfer to be a gift to the recipient. A single donor may give up to $11,000 a year, and married couples can give $22,000 a year. This can be in cash or assets to an unlimited number of people each year, without incurring any gift tax liability.

Gifts made in the amounts of more than $11,000 to one person in one year are considered to be a taxable gift, and as such can generate a potential gift tax. However, a gift tax is not due until you have given away over $1.5 million in your lifetime. This $1.5 million exemption means that most people will never have to consider paying any gift tax. Gifts that are eligible for the annual $11,000 exclusion currently only apply to gifts of property and income that the receiver can use immediately.

How Does A Legacy Tax Differ From An Inheritance Tax?

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

  • Who Receives The Property: When an inheritance tax is applied, the decedent gives their estate to a spouse, parent, or other family member. This is done through either a will left by the decedent or intestate succession if no such documents exist. Alternatively, legacy taxes are imposed when the decedent gives their property to someone who is not related to them; and
  • How The Tax Is Paid: Inheritance taxes are paid out by the person who inherits the property. An example of this would be when a person receives property valued at $10,000 from their deceased parent. They are responsible for paying the appropriate taxes on that $10,000. However, legacy taxes are paid out of the property that is 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. Meaning, the recipient does not personally pay anything simply for having received the property. They will not be required to pay legacy taxes after receiving the property.

To further compare, death taxes is a general phrase referring to various taxes that are imposed by the government on large transfers of property or money upon a person’s death. Death taxes are commonly known by other names such as estate taxes or succession taxes. While federal and state laws associated with estate taxes are frequently undergoing many changes and amendments, most estates are not large enough to have such a tax imposed on them.

A more specific form of a death tax would be the inheritance tax, which must be paid by people who receive property or assets from an estate after the testator dies. In contrast to estate tax laws, federal laws generally do not apply to inheritance taxes. Rather, inheritance tax laws are controlled by the states. Estate taxes are much broader than inheritance taxes and can cover circumstances outside of transfers to beneficiaries.

How Are Inheritance And Legacy Taxes Calculated? Can Inheritance And Legacy Taxes Be Reduced?

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

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

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

The calculation of inheritance taxes varies considerably by state, with most states requiring that the estate have a minimum worth before any taxes are imposed on the estate. If the estate does not meet a specific minimum value, inheritance taxes will not be required.

Inheritance taxes can be a large financial burden on the property’s recipient, and the tax requirements often outweigh 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 other financial and legal mechanisms, such as sale agreements, partnership arrangements, or gifts;
  • Purchasing life insurance in order to offset some of the costs associated with death and estate distribution;
  • Consider different inheritance and estate tax payment options for your specific state; or
  • Create a family trust which allows for transfers to be made to family members, and at less than full value.

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

Do I Need An Attorney For Assistance With Legacy Taxes?

If you are estate planning, or have received property from a decedent through their will or intestate succession, you should consult with an experienced and local estate attorney.

A local lawyer can help you understand your state’s laws regarding the matter, as well as your rights and legal options according to those laws. Your lawyer can also oversee your estate’s distribution, or ensure that you are paying the correct taxes.

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