Archive - Budget and Taxes

Questions & Answers About the Inheritance Tax

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Who pays the inheritance tax, and who benefits from its repeal?

The inheritance tax is a tax of 0.9 percent to 10 percent on inherited wealth. (The exact rate depends on the relationship of the heir to the person who died.) Most inherited wealth in Maryland is concentrated in a relatively small number of estates, and so most of the revenue from the inheritance tax comes from a handful of large estates. A study of inheritance taxes in 1993 found that 67 percent of inheritance tax revenue came from just 3,700 estates. Those estates had net assets greater than $300,000, a substantial amount by most Marylanders' standards. For reasons described below, some portion of those large estates would not benefit from repeal of the inheritance tax. Nonetheless, those large estates that did benefit would receive a substantial share of the total tax relief resulting from repeal of the inheritance tax.

At the other end of the spectrum, many Marylanders pass away without leaving any substantial assets to their heirs; those families would realize no benefit from repeal of the tax.

Would very large estates benefit from repeal of the inheritance tax?

Not all large estates would benefit from repeal of the inheritance tax. The reason is that under current law, an estate's inheritance tax liability acts as a dollar-for-dollar credit against the amount of tax it would otherwise owe under the Maryland estate tax. (The credit may be applied only against the Maryland portion of the estate tax, not against the federal portion.) For some very large estates, this credit entirely offsets the burden of the inheritance tax. For example, according to calculations by the Department of Legislative Services, a $1 million estate with inheritance tax liability of $9,000 (at the 0.9 percent rate) owes Maryland estate tax of $24,200, for a combined estate and inheritance tax bill of $33,200. If the inheritance tax were repealed, the estate's Maryland estate tax liability by itself would equal $33,200.(1) For that estate, then, repeal of the inheritance tax would provide no benefit.

On the other hand, some very large estates would nonetheless benefit from inheritance tax repeal. For instance, even taking into account the estate-tax offset, a $1 million estate facing the 10 percent inheritance tax rate would receive a tax reduction of $66,800 if the tax were repealed. (See Table 2. ) Some even larger estates would receive even greater tax breaks. According to the Department of Legislative Services, the tax reduction for a $5 million estate could be as much as $118,400.

Table 2
Inheritance and Estate Taxes for a $1 Million Estate

Even leaving aside the inheritance taxes paid by those estates larger than $1 million, repeal of the estate tax is likely to confer the greatest share of benefits on a small number of estates that, by most Marylanders' standards, are quite large. Of all inheritance taxes paid by estates of less than $1 million, about 52 percent of the taxes were paid by those estates with assets between $300,000 and $1 million - amount much larger than the wealth of most Americans.

What's the revenue loss from repealing the inheritance tax?

The Department of Legislative Services now estimates the net cost to the treasury of repealing the inheritance tax -- including the lost revenue that would ordinarily go to county Registers of Wills -- at $46.8 million in fiscal year 2002, the first year in which repeal could take full effect. That amount reflects the amount of inheritance tax revenue that the state would otherwise expect to collect in that year, about $82 million, minus about $35 million in increased estate tax revenue that the state expects to collect as a result of inheritance tax repeal. (The reason for the increased estate tax revenue is explained above.) This estimate accounts for increased appropriations to pay for the operations of county Registers of Wills, who presently receive revenue directly from the inheritance tax.

What tax changes have reduced inheritance and estate taxes in recent years?

Maryland has taken several steps to reduce inheritance taxes in the last several years.

• Certain family farms were exempted from the inheritance tax in 1996 (see below).

• Beginning in 1998, income earned by estates between the time of death and the time that the estate was distributed to heirs was exempted from inheritance taxation.

• Beginning in 1999, the inheritance tax rate paid by direct heirs was reduced from 1 percent to 0.9 percent, and the inheritance tax rate paid by siblings was reduced from 10 percent to 5 percent (phasing in over several years).

• In addition, large estates are benefitting from a gradual increase in the federal estate tax exemption from $600,000 in 1997 to $1 million by 2006. This exemption affects both the federal estate tax and Maryland's "pick-up" estate tax, which follows federal law on exemptions.

Is the inheritance tax "double taxation"?

A substantial share of the assets subject to inheritance tax have never been taxed. Thus, it is wrong to call the inheritance tax as a whole "double taxation."

• In the past, Maryland's inheritance tax was criticized as "double taxation" because the income earned by an estate between the time of death and the time the estate was distributed was subject both to Maryland income tax and Maryland estate tax. Such income was exempted from the inheritance tax by HB 762 in 1997, effective January 1, 1998.

• More significantly, the inheritance tax represents the only tax ever levied on unrealized capital gains income, which represents a major portion of many large estates. Under federal and Maryland tax law, capital gains income -- the income from the appreciation of assets such as stocks, bonds, and real estate -- is not taxed until the income is "realized" -- that is, until the assets are sold. If an asset is held until the owner dies, the gain in the value of the asset is never subject to the income tax. The heirs inherit the assets valued at the market price at the time of death and are not required to pay tax on any appreciation that took place during the life of the decedent.(2)

The inheritance tax provides a way of recouping a portion of the loss of revenue that results from the failure to tax unrealized gains. For instance, by accruing $100,000 in unrealized capital gains, a family can avoid paying as much as $4,850 in Maryland income tax(plus additional local income tax) that would have been paid if the income had been earned in nearly any other form. By subjecting that income to the 0.9 percent inheritance tax, Maryland can recoup a small portion ($900, or about one-fifth) of the unpaid income tax.

To what extent will repeal of the inheritance tax affect family farms and businesses?

Like other assets, ownership stakes in small businesses and farms may be subject to tax under the inheritance tax, and small business owners and farmers are likely to be among the beneficiaries of repeal. However, it is worth noting that most of the benefits of repeal will not go to small businesses and farmers.

• Family-owned business assets such as closely-held stocks, limited partnerships, and non-corporate businesses account for less than four percent of the value of taxable estates nationwide, according to an analysis by IRS of estates subject to the federal estate tax. The share of estates that are family farms is even smaller.(3)

• Under a 1996 law (SB 73), many family farms -- specifically, those of 50 acres or more that qualify for agricultural use assessment for property tax purposes -- are exempt from the inheritance tax if they are left to a lineal descendent.

Notes:

1.Department of Legislative Services, Inheritance and Estate Taxes: Presentation to the Tax and Revenue Subcommittee of the House Ways & Means Committee, October 19, 1999.

2.Iris J. Lav, Eliminating The Estate Tax: A Costly Benefit For The Wealthiest Americans, Center on Budget and Policy Priorities, 1999.

3.Lav, 1999.

Related Reports:

• Maryland Budget & Tax Policy Institute, Balancing Act: Cutting Taxes to Benefit Marylanders At All Income Levels, February 2000.

• Information about the Maryland inheritance tax from the county Registers of Wills.

• Have you inherited money? Click Here for information on paying Maryland's inheritance and estate taxes