Inheritance Tax

What is an Inheritance Tax?

An inheritance tax is levied upon an individual’s estate at death or upon the assets transferred from the decedent’s estate to their heirs. Unlike estate taxes, inheritance tax exemptions apply to the size of the gift rather than the size of the estate.

History of the Inheritance Tax

The United States government temporarily levied an inheritance tax for eight years beginning in 1862 to help finance the Civil War, and then again from 1898 until 1902 to help finance the Spanish-American War. The modern federal estate tax was enacted in 1916 and has remained law since. In 1926, the federal government began offering a generous federal credit for state estate taxes. This credit incentivized all states to impose an estate “pick up tax” because an estate’s total liability was the same whether or not a state imposed its own estate tax. This made estate and inheritance taxes an attractive revenue option for states. After the federal government fully phased out its state estate tax credit, many states stopped imposing estate taxes.

The federal government does not currently levy an inheritance tax. State inheritance taxes began with New York’s tax on collateral heirs in 1885 before spreading to 43 states by 1916. The number of states levying an inheritance tax has greatly declined over time, and now only a handful of states impose an inheritance tax.

Most states have been moving away from estate and inheritance taxes. Many states that retain these taxes have raised their exemption levels.

What Is the Impact of Inheritance Taxes?

Estate and inheritance taxes are administratively burdensome. Furthermore, they disincentivize business investment and can drive high-net-worth individuals out-of-state. When high-net-worth individuals leave a state to avoid its inheritance or estate tax, the individual’s state of origin loses not only the prospective estate or inheritance tax revenue but also the economic activity and revenue from other taxes that might have been collected during the individual’s lifetime. While it is less practical to avoid inheritance taxes, the tax nonetheless is inefficient and not conducive to economic growth.

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