Inheritance tax is a topic that tends to make people cringe – it’s not exactly the most exciting thing to talk about. But let’s face it; nobody wants their hard-earned assets and savings to be swallowed up by the tax man when they pass away.
Learning how to avoid inheritance tax is crucial. The rising costs of living, record inflation, and growing wealth disparity make it more challenging than ever to save money and leave an adequate inheritance for your heirs. Fortunately, there are ways you can legally reduce tax liability or even avoid paying inheritance tax altogether.
In this guide, we’ll explore the ins and outs of how to avoid inheritance taxes and provide practical tips on how you can protect your wealth for future generations.
What is an inheritance tax?
An inheritance tax is a tax that is imposed on the transfer of property and other assets from one person to another after they’ve died.
For tangible assets like property, the tax is levied on the value of the assets transferred, whereas cash inheritance is simply a percentage of the amount. The tax is paid by the person who inherits the property or other assets [beneficiary].
There are different rules in how an inheritance tax works from country to country. In Great Britain, there are no jurisdictional tax authorities; all tax policies are determined by HMRC (His Majesty’s Revenue & Customs). In contrast, territories of the United Kingdom, such as Gibraltar and the Cayman Islands, make their own tax rules.
The United States functions similarly. There are no federal estate taxes on inheritance, and decisions are not made at the federal level. Inheritance, gift, and capital gains taxes are determined at the state level. Many states in the US treat inheritance tax very differently. Some states have no inheritance tax, whereas others have tax rates as high as 20 percent.
Is inheritance tax a common practice?
An inheritance tax is a rare practice in most countries. In 2023, less than 30 countries levy an inheritance tax on beneficiaries ranging from four percent in Italy to 55 percent in Japan. This puts things into perspective when you remember that there are 193 United Nations member states worldwide. So, based on probability, most people worldwide don’t have to worry about paying inheritance taxes.
For example, China, Canada, and Russia have no inheritance tax. In Mexico, inheritance is treated as income under the income tax law and is tax-exempt for Mexican residents. Israel, Australia, and New Zealand previously had an inheritance tax but chose to abolish them in favor of simpler tax systems to encourage the creation of wealth, whether through investment or entrepreneurship.
In some countries with no inheritance tax, the only exception is the royalties paid to heirs (successors) of authors of literature, art, works of science, discoveries, inventions, and industrial samples, which can be subject to a personal income tax.
How much inheritance tax do you have to pay?
In order to dig deeper into ways you can avoid paying inheritance tax, it is essential to understand how much you may owe once you receive your inheritance.
The amount of inheritance tax owed generally depends on the value of the inherited assets and the relationship of the beneficiary to the decedent.
The value of the assets inherited
In the UK, the inheritance tax threshold is £325,000 ($400,000), meaning if the total value of what you inherit is below that amount, you won’t be liable to pay inheritance tax–this is also known as the “nil rate band.” Countries like Denmark have a much lower inheritance tax threshold, with a respective allowance of DKK 321,700 ($47,000).
The US has a similar system, although this functions as a state inheritance tax and isn’t related to federal taxes. For example, a state with an estate tax, like Nebraska, doesn’t impose an inheritance tax on assets below the value of $40,000, while New Jersey residents have an inheritance tax allowance of $25,000.
Generally speaking, even if you live in a country that charges an inheritance tax, you may not be liable to pay any tax at all. But the most important question is what you’ll be liable to pay once you’ve passed the tax threshold. Similar to income tax, inheritance tax is generally charged at progressive rates. So you will only pay the highest tax rate on the amount that exceeds the lower rate.
An example of this is Switzerland’s inheritance tax system, which imposes tax rates at increments of CHF 100,000 ($109,000):
- CHF 0 to 100,000: 1 percent
- CHF 100,000 to 200,000 ($218,000): 1.25 percent
- CHF 200,000 to 300,000 ($327,000): 1.5 percent
- CHF 300,000 to 400,000 ($436,000): 1.75 percent
- CHF 400,000 to 500,000 ($545,000): 2 percent
- CHF 500,000 to 600,000 ($654,000): 2.25 percent
- CHF 600,000 plus: 2.5 percent
The UK has a more straightforward tax system. The £325,000 allowance is high, but the standard tax rate is also high, at 40 percent.
The familial relationship between the decedent and beneficiary
In almost all cases, the amount of inheritance tax owed, and in some cases, if it is owed, comes down to the beneficiary’s relationship with the decedent. Generally, inheritance transferred between civil partners and married couples is exempt from inheritance tax; this often extends to the decedent’s children, depending on the country. There are also differences in tax treatment based on the child’s age.
For example, in the UK, if a person leaves behind £1.5 million ($1.85 million) in assets and their surviving spouse or a child under 18 is the only beneficiary, they would not owe any inheritance tax.
However, if that same person were to leave behind £1.5 million in assets and had three children over 18 as beneficiaries, each child would inherit £500,000 ($616,000), with the taxable amount per child being £175,000 ($215,000).
In Germany, a surviving spouse has an inheritance tax allowance of €500,000 ($542,000), whereas children of the decedent have an allowance of €400,000 ($433,000). There are different thresholds for other family members, like €200,000 ($217,000) for grandchildren and €100,000 ($108,000) for parents. Death within the family also influences how inheritance tax allowances are determined in Germany. For example, a grandchild has a tax allowance of €200,000, but if the grandchild’s parent is deceased, the allowance rises to €400,000.
Inheritance Tax in Europe
Most European countries have some form of inheritance tax. This tax is levied on the beneficiaries of the decedent’s estate, with the money going to the state. Taxes vary from country to country. In some cases, it can be as low as one percent, and in others, as high as 50 percent of the inheritance value based on several factors.
Here is a comparison of inheritance tax by country in Europe.
The United Kingdom
Beneficiaries: A spouse or civil partner of the decedent is exempt from inheritance tax in the UK. All other beneficiaries are liable to pay the full rate of the tax.
Tax rate: The UK has a fixed inheritance tax rate of 40 percent.
Tax allowance: Inheritance under £325,000 is tax-exempt for all beneficiaries.
Beneficiaries: All beneficiaries are liable to pay inheritance tax in France, but the children of the decedent have a tax-free allowance of €100,000.
Tax rate: France has a tax band system to determine inheritance tax rates. The bands work as follows:
- €0 to €8,072 ($8,747) = 5 percent
- €8,072 to €12,109 ($13,121) = 10 percent
- €12,109 to €15,932 ($17,264) = 15 percent
- €15,932 to €552,324 ($598,500) = 20 percent
- €552,324 to €902,8380 ($978,000) = 30 percent
- €902,838 to €1.8 million ($1.95 million) = 40 percent
- €1.8 million plus = 45 percent
Tax allowance: There is no universal inheritance tax allowance in France, but the children of the decedent have a tax-free threshold of €100,000.
Beneficiaries: There are four classifications for beneficiaries in Italy:
- Spouse or direct relatives (i.e., parents, children, grandchildren, and grandparents)
- Other relations up to the fourth degree of kinship
- All other persons
Tax rate: Italy employs a variable tax rate approach for beneficiaries.
- Four percent for the spouse or direct relatives
- Six percent for siblings
- Six percent for other relations up to the fourth degree of kinship
- Eight percent for all other persons
Tax allowance: Tax exemption is also determined by the beneficiary’s relationship to the decedent:
- Spouse or direct relatives = €1 million exemption
- Siblings: = €100,000 exemption
- Other relations up to the fourth degree of kinship = No exemption
- All other persons = No exemption
Beneficiaries: Inheritance beneficiaries are categorized into three different groups in Greece:
- Category one: Spouse, parents, children, and grandchildren
- Category two: Grandparents, great-grandchildren, brothers- and sisters-in-law, parents-in-law, and children of the decedent from previous marriages
- Category three: All other family members who are not included in the above categories and do not have a kinship with the decedent
Tax rate: Generally speaking, Greece has a tax rate of one to ten percent for category one beneficiaries. The rates are applied as follows:
- €0 to €150,000 ($163,000) = tax-free
- €150,000 to €300,000 ($325,000) = one percent tax rate
- €300,000 to €600,000 ($650,000 = five percent tax rate
- €600,000 plus = ten percent tax rate
The inheritance tax rate varies for beneficiaries in categories two and three and can be as high as 40 percent.
Tax allowance: The standard tax allowance is €150,000; however, this only applies to category one beneficiaries. The spouse (after five years of marriage) and their minor children have a special tax allowance of €400,000. All other family members and individuals pay tax on all inheritance received.
Beneficiaries: There is no inheritance tax in Portugal for the spouse, children, grandchildren, parents, and grandparents of the decedent. All other beneficiaries are liable to pay stamp duty.
Tax rate: Stamp duty is charged at ten percent in Portugal.
Tax allowance: The surviving spouse, direct descendants, and ascendents are exempt from inheritance taxes in Portugal. Other beneficiaries may reduce their estate tax burden through Portugal’s double tax treaty with their home country.
Beneficiaries: There are four group classifications for beneficiaries based on their relationship to the descendent in Spain:
- Group one: Children under the age of 21
- Group two: Children over the age of 21, grandchildren, spouses, parents, and grandparents. Some regions may recognize unmarried partners registered under a pareja de hecho (domestic partnership).
- Group three: Siblings, aunts, uncles, nieces, nephews, in-laws, and their ascendants and descendants
- Group four: Cousins, all other relatives, unmarried partners (if the region allows it), and those who are unrelated
Tax rate: Spain has a progressive tax rate for inheritance.
- €0 to €7,993 ($8,661) = 7.65 percent
- €7,993 to €31,956 ($34,600) = 10.2 percent
- €31,956 to €79,881 ($86,500) = 15.3 percent
- €79,881 to €239,389 ($259,000 = 21.25 percent
- €239,389 to €398,778 ($432,000) = 25.5 percent
- €398,778 to €797,555 ($864,000) = 29.75 percent
- €797,555 plus = 34 percent
Tax allowance: Tax exemption is also determined by the beneficiary’s relationship to the decedent:
- Group one beneficiaries have a tax allowance of €47,859 ($51,800)
- Group one beneficiaries have a tax allowance of €15,957 ($17,300)
- Group one beneficiaries have a tax allowance of €7,993
- There is no tax allowance for beneficiaries in group four
Inheritance left to vulnerable people
In most countries that charge inheritance taxes, there is generally special tax treatment to reduce the tax bill or avoid paying taxes on inheritances left to vulnerable people, such as children with disabilities.
The maximum inheritance allowance in France is €47,859 for group one beneficiaries; however, this can be as high as €50,253 ($54,400) for a disabled group one beneficiary, depending on the extent of the disability.
Inheritance and gift tax – known as Capital Acquisition Tax in Ireland – is levied on all beneficiaries of inheritance in Ireland at a standard rate of 33 percent. Disabled beneficiaries are eligible to claim qualifying expenses are expenses for healthcare, including the cost of maintenance associated with medical care, to reduce the taxable amount.
The maximum inheritance allowance in Italy is €1 million ($1.08 million) for a spouse and direct relatives (parents, children, grandchildren); however, this rises to €1.5 million for disabled children.
Inheritance Tax Versus Estate Tax
There has been much debate over the merits of inheritance tax versus estate tax in recent years. An inheritance tax is imposed on heirs when they receive assets from a deceased person.
The amount of the tax is based on the value of the assets inherited. This type of tax can be seen as a way to prevent large sums of money from being passed down through families, and it often affects wealthier individuals.
On the other hand, an estate tax is imposed on the entire estate of a deceased person, regardless of who inherits the property. The amount of the tax is based on the entire estate’s value. This type of tax can be seen as a way to ensure that everyone pays their fair share, and it affects both the rich and poor alike.
Proponents of inheritance taxes argue that it is a more just way to tax individuals because only those who have inherited money or assets pay taxes. On the other hand, the estate tax taxes everyone regardless of whether they have inherited anything.
Critics of inheritance tax say it disproportionately affects the wealthy, who are more likely to receive large inheritances. They also argue that it can be challenging to value inheritances accurately, leading to unfairness. Supporters of estate tax counter that it is a more effective way to raise revenue, as it taxes all individuals regardless of their wealth or income.
Estate Tax in the United States
The United States federal government has a federal estate tax – also known as a death tax – which is imposed on a deceased person’s assets and property transfers. The estate tax is calculated on the value of the property included in the decedent’s gross estate. A federal estate tax is one of several taxes imposed on the transfer of property at death, although not all states impose a state estate tax, and they’re also eligible for a federal estate tax exemption to avoid estate taxes.
Estate taxes are an outright tax, meaning regardless of who inherits the property, the tax is charged on the entire estate. The American Taxpayer Relief Act of 2012 changed the federal estate tax rules so that for decedents dying after 31 December 2012, the minimum estate tax rate is 18 percent, and the maximum estate tax rate is 40 percent.
This includes a federal estate tax exemption (the amount that can be passed to heirs free of estate taxes) of $12.92 million as of 2023, increasing from $12.06 million in 2022. These changes to estate taxes are permanent and do not need to be renewed by Congress.
In addition to these changes in the death tax, there is a “portability” provision that allows a surviving spouse to avoid estate taxes by using any unused portion of their deceased spouse’s estate tax exemption in their estate plan. This provision reducing estate tax liability applies to taxable estates, whether liable to federal or state estate tax, of decedents who die after 31 December 2010.
How to Reduce Inheritance Tax
Inheritance tax can be a significant estate tax burden for many people. However, there are many ways to reduce the amount of federal inheritance tax you will have to pay.
Consider an alternate valuation date
An alternate valuation date typically is a date used to value assets for tax purposes. The most common alternate valuation date is the date of the decedent’s death, but other dates may be used in certain circumstances. For example, if the decedent owned real estate valued at less than its fair market value on the date of death, an alternate valuation date generally reduces inheritance tax.
There is also usually a grace period allowed for the tax to be paid, which is generally six months from the date of death. Therefore, if the inherited assets are received in a declining market, it may reduce inheritance taxes due.
The use of an alternate valuation date is not without controversy, however. Some argue that it unfairly benefits those who are able to take advantage of it, while others contend that it is a necessary tool to ensure that taxes are paid on the true value of an asset. Ultimately, whether or not to use an alternative valuation date is a decision that must be made on a case-by-case basis.
Consider life insurance as a means to transfer assets
A life insurance policy with heirs as the beneficiaries is a preventive measure to reduce inheritance tax before death. Life insurance proceeds are not seen as taxable income, so when you die, your beneficiaries receive the policy’s proceeds without being liable for tax.
Another advantage of using life insurance proceeds to transfer assets is that it can be done quickly and easily. You don’t have to go through the probate process, which can be lengthy and expensive, and unlike cash and tangible assets like property, there are no limits on how much you can give away through a life insurance policy.
If you’re considering using life insurance proceeds as a means to transfer assets and reducing tax liability, be sure to talk with an experienced estate planning attorney or tax professional to make sure it’s the right decision for your situation.
Put your assets in a trust
Several variations of trusts can be created; bare, discretionary, accumulation, and non-resident trusts to name a few. The two most common types – and most pertinent regarding estate and inheritance taxes – are revocable trusts and irrevocable trusts.
As the names suggest, the two operate very differently; here is a brief explanation:
- A revocable trust can be altered after creation, and the grantor can retrieve the trust assets.
- An irrevocable trust is final. The trust assets permanently belong to the trust and cannot be recovered.
Once assets have been transferred to an irrevocable trust, the trust becomes the owner of the assets, and thus, that portion of the estate is no longer subjected to inheritance or estate taxes.
It may sound excessive and even counter-productive, but this lack of flexibility is the buffer that protects the assets of an individual and their heirs from inheritance taxes as well as malicious lawsuits later in life.
The benefits of an offshore irrevocable trust
Offshore banking has become a popular way for investors to diversify their assets and protect their wealth when creating an estate plan. There are several benefits of offshore banking before even thinking about opening a trust:
- It reduces your federal tax burden by providing eligibility for foreign tax credits and and tax exemption to reduce federal taxes
- You can reduce your tax bill and avoid taxes such as wealth and gift tax in countries that don’t impose taxes on worldwide assets.
- You can protect your assets from economic and political turmoil in your home country.
- You can gain citizenship by investment if the assets are transferred to a country that offers citizenship in exchange for an investment in the economy.
Concerning offshore trusts, as briefly outlined, an additional layer of protection is added to trust assets held in an offshore bank. Many offshore banks also provide the option of opening an irrevocable life insurance trust.
Leave money to charity
Leaving charitable donations in a will or transferring assets to charitable trusts is one of the simplest ways to reduce inheritance taxes.
In the UK, for example, allocating more than ten percent of the taxable amount to charitable lead trusts or nonprofit organizations (the same goes for political parties and local sports clubs) will reduce estate tax from 40 percent to 36 percent.
The ten percent only applies to the value over the taxable amount (£325,000). So, if £600,000 ($739,000) was left behind, the lower rate can be applied if more than £27,500 (ten percent of the amount over £600,000) is given to charity.
Although leaving money to charity isn’t a method of giving a larger portion of the estate to beneficiaries, charitable donations are a way to ensure that funds received from the sale of assets are spent in a way of your choosing.
Frequently Asked Questions about How to Avoid Inheritance Tax
What country does not tax inheritance?
There is no inheritance tax in Malta. Instead, the beneficiary pays a transfer duty at five percent of the declared property value.
How do Germans avoid paying inheritance tax?
Germans commonly reduce the taxable amount on inheritance by requesting a tax deduction on things such as funeral expenses and administrative fees. Taxes are also avoided when estate planners pay larger amounts into retirement accounts, as money within a pension is exempt from German inheritance tax.
Additionally, as the tax rates and tax-free allowances for inheritance vary depending on the relationship to the decedent, they can ensure that the largest portion of their estate goes to relatives that receive the highest tax allowance along with the lowest tax rate.
Does Europe have an inheritance tax?
There are no universal inheritance taxes in Europe. Each country has its own tax laws. European countries, like the UK, impose an inheritance tax of 40 percent. In contrast, Malta is an ideal country to avoid inheritance tax in Europe in 2023, as there is no inheritance, wealth, or capital gains tax.
Which countries in Europe have no inheritance tax?
Regarding how to avoid inheritance tax in Europe and reduce the taxable estate, the best way is to move your wealth to European countries with no inheritance tax, such as Austria, Cyprus, Estonia, Latvia, Malta, Portugal, Romania, Slovakia, and Sweden.
How do the French avoid paying inheritance tax?
A few ways French citizens and tax residents reduce the taxable estate and avoid estate taxes are:
- Opening a life insurance policy
- Transferring property before death
- Paying the gift tax before death
- Investing in real estate through an SCI (société civile immobilière) property holding company