Inheritance tax

Inheritance tax, often referred to as estate duty or death tax, is a levy imposed on the estate of a deceased individual. This tax is assessed and collected from the estate prior to the distribution of assets to the beneficiaries named in the Will or those determined by intestate succession laws. The tax ensures that the estate fulfills its fiscal obligations before the assets are passed on to heirs.

Have you lost someone recently? If yes, we are sorry for your loss. However, your loss may also mean that you have inherited some money, property, or other assets. But when you inherit anything from your deceased relatives, you have to pay an inheritance tax to the government as a beneficiary of the inherited assets. Depending on the country in which you live, the inheritance tax may go as high as 55%. Learn about the meaning of inheritance tax, how to calculate the tax rate, the way to avoid inheritance taxes, the tax rates in India and USA, and more in the following sections.

What is an inheritance tax?

If you receive a property, mutual fund, gold, and other movable or immovable items either as ancestral property or inherit from a deceased person through Will, you may have to pay tax on your inheritance. This tax is known as inheritance tax. Inheritance tax laws and rates vary from one country to another.

It is important to note that an inheritance tax is different from an estate tax. An inheritance tax is paid by the person who inherits movable or immovable properties. In the case of the estate tax, it is paid by the estate.

History of Inheritance tax

Every country has its own inheritance tax rates, rules, and regulations. In accordance with the country you are in, the name may also change. In many countries, it is also called estate tax, gift tax, and sometimes even death duty tax.

But how did it all start? What is the origin of inheritance tax? How do they change over the years? Let us check the history of inheritance tax. Let us first check the same in the US and then India.

Also read: Long Term Capital Gains Tax

History of inheritance tax in the USA

In the US, inheritance tax was first introduced during the Civil War. For financing the Civil War, the inheritance tax was introduced in 1862 as part of the Revenue Act of 1862. It continued for 8 years. During the Spanish-American War, the inheritance tax was again reinstated in 1892 and it continued till 1902.

The origin of the modern-day inheritance tax (which is known as federal estate tax) can be traced back to 1916. The unified transfer tax system of the federal government consists of:

• Estate tax: It deals with the taxes related to the contents of an estate.

• Gift tax: If wealth is transferred from one person to another, then it comes under the gift tax.

• Generation-skipping tax: If a person transfers his/her wealth to a more distant descendant, it is dealt by the generation-skipping tax.

However, the federal transfer tax system has gone through various modifications through legislative acts. One of the major changes took place through the Omnibus Budget Reconciliation Act of 1987. One one hand, it extended the top marginal rate to 55%, on one hand, and on the other phased out benefits for certain transfers. In 1993, these provisions were reinstated retroactively.

History of inheritance tax in India

In 1953, under the Estate Duty Act, the first-ever inheritance tax was introduced in India. It was levied upon the inherited estate’s principal value if it surpassed a threshold level. Depending upon the relation you have with the deceased person and also the total value of the estate, progressive tax rates were applicable under the Estate Duty Act. However, the landscape of the legislature has changed significantly over the years.

Also read: Income tax return extended date 2024

Is there an inheritance tax in India?

No, there is no inheritance tax in India currently. Inheritance tax or estate tax was there in India after independence since the Estate Duty Act was implemented in 1953. However, it was abolished in 1985. Currently, many discussions are going on that propose levying taxes on any asset you inherit.

Though you do not have to pay any inheritance tax for receiving any inherited property, you may have to pay taxes on any income generated from your inherited property either through rental or interest. Therefore, you should mention these incomes under "Income from Other Sources” while filing your income tax return in India. In addition, you may also have to pay property taxes regularly after the inherited property has been registered in your name.

Do you have to pay any inheritance tax in the USA?

If you live in any of the six US states including New Jersey, Nebraska, Kentucky, Pennsylvania, Maryland, and Iowa, you may have to pay inheritance tax. The amount of tax you pay depends on the ongoing value of the inherited property. The relationship you have with the deceased person will also decide the inheritance tax rate.

Also read: Section 56 of Income Tax Act

How do you calculate inheritance tax?

The way you calculate your inheritance tax varies as per the location you live in. If you live in India, you have to pay zero inheritance tax.

However, people living in specific locations in other countries may have to pay taxes for inheriting properties or other movable/immovable assets.

Generally speaking, you can calculate your payable inheritance tax by following the steps mentioned below:

Step 1: Determine your inherited asset’s gross value

You have to calculate the total market value of the deceased person’s total assets you have inherited. It may include all his investment holdings, vehicles, real estate properties, and all his personal belongings.

Step 2: Deduct any debt or liability

If the inherited estate has any debt or liability, it has to be deducted from the gross value of the inherited assets

Step 3: Exclusions or exemptions

Are there any applicable exclusions or exemptions that you can apply? If yes, please deduct it from the estate’s taxable value.

Step 4: Calculate the taxable value

Once you have deducted debt, liability, and exemptions/exclusions from the gross value of the inherited estate, you have to calculate the value on which the inheritance tax rate will be applicable.

Step 5: Calculate the inheritance tax

Once you have calculated the taxable value of your inherited assets, you have to apply the inheritance tax rate as per the location and country to get the total amount of tax you have to pay for inheriting assets.

Also read: Short Term Capital Gains Tax

What are the different types of inheritance taxes in India?

As you already know from the above discussion there are no inheritance taxes in India. This means you do not have to pay any inheritance taxes when you receive any property or any other asset class. However, you have to declare your inheritance at the time of filing your annual tax return. But how can you describe the inherited property? You may receive the property through a will of succession. It can also be through inheritance by nomination or by joint ownership.

So, let us explore the three types of inheritance in India:

Will of succession

When a person creates a will and chooses a legal heir, then after his/her demise the legal heirs mentioned in the will receive the inherited property and other assets. This will be prepared by the testator (one who makes the will and also signs it) and is known as the will of succession. The rules of succession are governed by the Indian Succession Act. This ensures that all the wishes made by the deceased person in the succession will be respected.

Inheritance by nomination

Inheritance can also be done by appointing a nominee. When you open a new bank account, buy a new mutual fund, insurance policy, or share, you have to mention the name of your nominee. The government of India has put more importance to it in recent years. When the name of a nominee is mentioned, it does not grant that person absolute ownership. A nominee can get those assets transferred to his/her name only after that person’s demise. This is called inheritance by nomination.

Inheritance by joint ownership

If there is an inheritance by joint ownership, it means that multiple family members or individuals can become joint owners of the inherited property. Based on the property type (such as investments in shares or mutual funds, real estate, or joining bank accounts), the legal framework may change. In the case of the demise of any one of the joint holders, other surviving joint holders of that property will automatically inherit the share of the deceased person.

Also read: Section 80C of Income Tax Act

What is the taxation on Inherited Assets?

Though there are no inheritance taxes in India, there are a couple of tax implications that you have to keep in mind as an inheritor of a property. Let us explore the most important ones:

Implications of income tax

Suppose you have inherited a house and you are using this property for rental income. As you are the new owner of the inherited property and also earning rent from tenants, you have to declare this income while filing your income tax return. If the income is above the threshold limit, you have to pay taxes as per the income tax slab rates.

Capital gains tax on selling the inherited property

Depending upon the duration you hold an inherited property, you may have to pay long-term or short-term capital gains taxes when you sell the property. The exact tax rate will be dependent on your specific situation. So, always consult a tax professional before selling an inherited property.

Tax on Inheritance of Immovable Property in India

No inheritance tax is applicable on you when you inherit immovable property in India. However, you may have to pay a capital gains tax on the profit you made by selling the inherited immovable property.

If you sell the inherited property within two years from the date of inheritance, you will have to pay as per the existing income tax slab. If your property is more than 2 years old, you qualify for long-term capital gains tax and therefore you have to pay a 20% tax rate after making an inflation adjustment.

You will also need to pay property taxes if you inherit any immovable property. In the case of making rental income from the inherited immovable property, you have to pay taxes at the time of filing tax returns.

Tax on Inheritance of Movable Assets

If you are a legal heir, joint owner, or nominee, you do not have to pay any inheritance tax on your movable assets. However, you have to fulfil certain formalities in such cases.

Suppose, you have inherited a bank account. In that case, you have to change the name of the account to Account Holder Deceased but no taxes have to be paid.

When you inherit a locker, all the belongings are transferred to you and also no taxes are levied upon you.

In case you inherit a car, you have to file an application with the state RTO to transfer the vehicle under your name as its new owner.

Also read: Tax on dividend income

Income Tax Implications on Inheritance

The legal heirs inherit a property in case of the owner’s sudden death. Under the Income Tax Act of 1961, no inheritance tax is applicable. Just for property transfer to your name, there are no income tax implications on inheritance. Only when you earn rental income from the inheritance (say, it is real estate), do you have to pay according to existing tax slabs.

Tax on Income from Inheritance

Suppose, you have inherited a property, which was the sole income of the owner. After his/her demise, you will be the legal heir of that property. In such a case, the income from inheritance also gets transferred to you. Therefore, you have to declare this income at the time of tax filing and accordingly pay income taxes as per existing tax slabs. However, you do not have to pay any inheritance taxes for simply inheriting the property.

Also read: How to Avoid LTCG Tax on Mutual Funds

Tax on Subsequent Sale

When you inherit a property, you become its new owner. As you are the new owner, you can decide whether you want to keep it or sell it. If you keep it, you just have to pay annual property tax, just like any other person owning real estate has to pay. No inheritance tax is levied upon you just for the transfer of the inheritance.

But as the new owner of the property, you decide to sell it. In that case, you earn a profit by selling the inherited property. As a legal heir of the property, you make a capital gain by selling it.

Therefore, you have to pay capital gains tax when you sell an inherited property. If you sell the inherited property before 2 years from the date of inheritance, you will have to pay a short-term capital gains tax. In case the sale is done after 2 years, you will have to pay a long-term capital gains tax of 20% (after adjusting for inflation).

What are the taxes on inherited mutual funds?

The Income Tax Act of 1961 has not levied any taxes on inherited mutual funds or other movable assets such as shares, gold, and others. If you have inherited any movable item such as a mutual fund, you are not required to pay any taxes as a new owner. Though transferring the movable item is not taxed, you are liable to pay capital gains tax if you decide to sell the inherited mutual funds or other inherited movable items like gold or shares.

Also read: Long Term Capital Gain Tax on Property

New tax basis for inherited mutual fund shares in taxable accounts

If you inherited any mutual fund, there is a tax law called the basic step-up rule, applicable for all regular taxable accounts. According to this tax accounting practice, no matter when the original mutual fund share was bought, the basis of taxing is done on the basis of the mutual fund scheme’s NAV value at the original owner’s date of death. It is applied to all the mutual fund shares you inherit. This ensures that all the inherited shares by the legal heir have a new cost basis.

Inherited mutual fund shares in IRAs or other retirement accounts are more complicated

In the case of IRAs or other retirement accounts, the basis step-up rule (explained above in the previous section) is not applicable.

Let us check the implications for different retirement plans:

• IRA, 401(k), and standard employer retirement plan account: If the mutual fund shares are sold, no immediate tax will be applicable. The proceeds of selling the fund that the heir gets is a taxable income.

• Roth IRA, Roth 401(k), or other Roth-eligible employer plan account: No tax will be triggered by the distribution of the proceeds.

That is why the taxation of inherited mutual fund shares in IRAs or other retirement accounts is so complicated.

When is inheritance tax levied?

In the US, levying an inheritance tax is a state subject and not a federal one. The states where inheritance taxes are present include Pennsylvania, New Jersey, Nebraska, Maryland, Kentucky, and Iowa. You have to pay inheritance tax in these states, especially on the amount that exceeds an exemption amount.

Limitations of inheritance tax

Inheritance tax has 3 major limitations:

• Double taxation is a major concern when it comes to inheritance tax. There are high chances that assets are taxed twice. The first time tax is levied during the lifetime of the original owner and the second time in the form of inheritance tax when the legal heir inherited the property (movable or immovable). This is a pain point for many, especially for those who have already paid their taxes on their assets.

• Wealth redistribution is one of the main objectives of implementing inheritance tax. It wants to redistribute wealth and lessen wealth inequality. However, inheritance tax may not be able to tax all forms of wealth, which may include offshore accounts, etc.

• Complexity and compliance costs of inheritance tax systems is its third limitation. As it is complex to implement, time-consuming, and costly (administrative costs are high), inheritance tax tends to create errors and inefficiencies in the tax system. This is one of the reasons why India abolished inheritance tax back in 1985.

Also read: How to Fill ITR 2 for Capital Gains

Inheritance tax vs. Estate tax

There are multiple differences between estate tax and inheritance tax in the USA. Let us explore the most glaring ones here.

Onus of Payment

Upon the owner's death, the estate tax is paid by the estate. However, in the case of inheritance tax, it is paid by the inheritor of the property.

Jurisdiction of collection

While estate tax is collected at both federal and state levels, inheritance tax is collected at the state level only.

Threshold value

While inheritance tax has no threshold level for tax collection, estates with smaller sizes and values below a benchmark level are exempted from paying any estate taxes.

Final words

In India, you do not have to pay any such taxes on assets you inherit. It may include real estate, mutual funds, stocks, and other movable/immovable assets. However, in the US, they still have inheritance tax in six US states. So, always check the local laws, rates, and guidelines of inheritance tax.

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