While both taxes apply at a person’s death, many people refer to these two taxes interchangeably, but they actually operate in very different ways.
A state estate tax is derived from the total value of an individual's (or decedent’s) estate and how it measures up to the state’s estate tax exemption. An inheritance tax, on the other hand, is based on the beneficiaries, their relationship to the decedent, and the value of the estate that will pass to certain types of beneficiaries.
The Star-Ledger took up this often confusing subject in a recent article titled “Biz Brain: Inheritance tax liability confusion.”
In other words, the estate itself can be taxed for the amount that is above the exemption cut-off. If the total value of the estate falls below the exemption line, then there is no estate tax applied.
The inheritance tax is a tax on the beneficiary's gift. The beneficiary of the property is responsible for paying the tax him or herself—not the estate. You can, however, breathe a little easier as there are now only eight states that impose an inheritance tax [Indiana, Iowa, Kentucky, Maryland, Nebraska, New Jersey, Pennsylvania and Tennessee]. But even if you live in one of those states, many beneficiaries may end up being exempt from paying the inheritance tax.
These two types of taxes often get confusing, and if a fair amount of planning isn't done before a person passes away, it can cause headaches for those who are to receive something from the estate.
The best course of business is to speak with an experienced estate planning attorney who has the background and skills necessary to make the estate plan easy-to-understand both for the owner while he or she is still alive—as well as for the beneficiaries when the estate is being probated. In addition, and equally as important, is working with an attorney to avoid unnecessary tax consequences for everyone involved.
Reference: The Star-Ledger, February 23, 2014: “Biz Brain: Inheritance tax liability confusion”