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Many countries have special laws regarding inheritance taxes. Why would this be treated separately when it could just be taxed equally to all other income?

Suppose Eve normally earns €50,000 per year. Due to an inheritance, one year, Eve earns €150,000. Why do we need an inheritance tax — one could just tax an income of €150,000?

We might want to tax income one has worked for less than income one has not worked for, but this could be organised by declaring both income from labour and total income separately. However, it seems rather that in some countries, inheritance income one hasn't worked for is taxed less than income from labour. I don't see how that makes sense. Eve is not a charity.

There is a related question, What ethical (if any) or economical arguments are offered in defense of the inheritance tax?, but that one is sort of the other way around, because the asker seems to imply that inheritances should be taxed less than income from labour. If there is no inheritance tax (Wikipedia lists various countries that have abolished them) it should be just taxed like all other income, I suppose.

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    Does this answer your question? What ethical (if any) or economical arguments are offered in defense of the inheritance tax? I don't think the questions are different enough IMO Nov 20, 2022 at 2:32
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    Close-voters: I have already explained in the question why I don't think the linked question answers my question.
    – gerrit
    Nov 20, 2022 at 16:56
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    Both Q's seem to be pretty much "why is inheritance taxed the way it is" followed by each of your opinions, which don't really matter. For example "when were cats domesticated? I think it was recently" is the same as "when were cats domesticated? I think it was very long ago". Nov 20, 2022 at 23:00

18 Answers 18

48

Historically, inheritance was a family affair
The family being a single economical unit, spanning generations. Parents and children working together for the common survival, as a farm or small business.
The concept that society has inherited (pun intended) is: Inheritance is not income, it is just redistribution of common wealth within the same family. Each heir has already worked to create this wealth, the family income has already been taxed.
The concepts of family, income, state, tax etc. have evolved, the importance of private income, individual wealth and inheritance has changed, as well as the relations between parents and children.
What is just (or should be) regarding inheritance and taxation seems to be the core of this question. My answer can only be: whatever society decides. I gave some explanation how the current state has evolved. How it will evolve further is how society as a whole may answer the question.

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    I like this answer, because it points out how, culturally, we consider the family as a unit and the wealth to be property of the family as a commune rather than to the individual. And I believe that in many countries, if I inherit money from a total stranger, I pay more tax on it than if I inherit from my parents.
    – gerrit
    Nov 20, 2022 at 16:54
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    "Each heir has already worked to create this wealth", hahaha
    – njzk2
    Nov 21, 2022 at 17:51
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    @njzk2 Have an ungrateful son, do you? A prodigal that already took his half?
    – user2578
    Nov 21, 2022 at 18:42
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    @frеdsbend ? I'm just saying that people don't typically work toward the wealth of their parents
    – njzk2
    Nov 21, 2022 at 21:22
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    @njzk2 Maybe not as much in your experience but, for example, having a farmer's children help out around the farm was, at least historically, expected. The same goes for many businesses, be it a corner shop or plumber - some help is still likely to be provided by family and help towards the progression of that wealth. I expect the examples you're thinking of are where the parents work salaried jobs? Nov 22, 2022 at 13:15
27

(this answer is a bit meh)

You could tax it the same way, but people don't want that.

Inheritance is different. People don't choose to inherit. People can't change their behaviour to inherit more or less, or earlier or later.

Generally different forms of income are taxed differently. Capital gains are taxed differently from income (and capital gains on property are taxed differently again). Gambling winnings have a different tax system. Severance pay is not taxed the same as bonuses.

The government sets a tax system that it thinks can be "sold" to a public (who want public service, but would rather not pay tax) can raise money from those who are able to pay and doesn't harm those who can't. The tax system must raise enough money to pay for public services without being so unpopular that the government gets voted out. To walk this tightrope, government find it necessary to tax different forms of income differently.

But Meh the government could tax inheritance the same as other income, but it might not stay in government long if it did.

So the answer is political not economic.

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    So the answer is political not economic. (double-checking) That's why I asked this on Politics and not on Economics :)
    – gerrit
    Nov 19, 2022 at 22:42
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    In Germany, one CAN indeed refuse an inheritance, and I think this is often done when it is likely that the desceased person left net debts (for which the inheritor would otherwise be liable). I think the decision deadline after the death is not especially long, but I can't recall.
    – kpollock
    Nov 21, 2022 at 9:30
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    @kpollock: Yes, it's called Erbausschlagung, and the deadline is usually six weeks after learning of the inheritance.
    – sleske
    Nov 21, 2022 at 9:33
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    "People can't change their behaviour to inherit more or less, or earlier or later." Arguably, you could change your behaviour to inherit earlier, but if you did we'd be talking about it on the Law SE site...
    – DBS
    Nov 21, 2022 at 13:38
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    People don't choose to inherit They do, at lest in may EU countries where you can refuse an inheritance.
    – WoJ
    Nov 22, 2022 at 16:18
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Suppose Eve normally earns €50,000 per year. Due to an inheritance, one year, Eve earns €150,000. Why do we need a special inheritance tax — one could just tax an income of €150,000?

Suppose instead that Eve inherits €5,000,000. The taxes on that as a one year income would be immense. Moreover, that €5,000,000 represents income her parents earned on which they had already paid taxes. In one sense, it would be unfair to tax that already taxed income. However, in another sense, those large inheritances represent a key factor in wealth disparity. Many countries allow some amount to be passed down generation to generation tax free but do tax what are deemed to be excessive inheritances.

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  • Comments are not for extended discussion; this conversation has been moved to chat.
    – Philipp
    Nov 24, 2022 at 9:54
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Inheritance may be a bank account or stock portfolio. But often it involves things like a single-family home, or a small business. Taxing this at the same rate as income would force the inheritor to sell it off and re-invest the remaining inheritance, which is seen by the public as undesirable.

Of course, as mentioned in the comments, public opinion is shaped by those with an interest to try and shape it. In one perfidious issue is the mix-up of Mittelschicht (middle classes) and Mittelstand (small and medium businesses, i.e. no more than a couple hundred employees). Any attempt to tax the Mittelstand owners gets portrayed by the Mittelstand lobbyists as an attempt to tax the Mittelschicht. And members of both the upper end of the lower class and the lower end of the upper class like to self-identify as middle class.

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    OP doesn't think income and inheritance should be strictly taxed at the same rate as explained in the question. But yes, making it a different tax is more intuitive.
    – sourcream
    Nov 20, 2022 at 12:51
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    "would force the inheritor to sell it" Doesn't have to. Often one can pay due taxes in rates over time if the amount of taxes to be paid is so high. Nov 20, 2022 at 21:33
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    @Trilarion Paying off over time is not always a possibility. A small farm in Western Europe, for example, is usually just about surviving. If the next generation has to pay half of its value when inheriting, what do they do? Sell half the fields? Same for a small business, do they sell half of the workshop or the equipment?
    – RedSonja
    Nov 21, 2022 at 7:29
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    @Trilarion Well, I was a farm kid. A small farm or business invests its surplus in the business. Having to pay yet another tax would force them to sell up. No-one benefits from that. Well, the big farming concerns do, they get the land cheap and employ cheap labour to produce the cheap stuff supermarkets want. Some people may find that good.
    – RedSonja
    Nov 21, 2022 at 8:16
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    @jwenting I assume if you inherit a 300k home you could put a 75k mortgage on it to cover inheritance taxes?
    – florian
    Nov 22, 2022 at 10:26
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As stated by James K and alluded to in other answers, you can make the case that inheritance is a very special kind of income. Inheritance resembles donations, and some countries will use the exact same tax for donations and inheritance.

Once you agree inheritance is a singular way of obtaining assets, creating a special tax out of it has some procedural advantages for a government:

  • You can choose different collectors for the new tax. For example, in Brazil, inheritance tax is collect by states, while regular income tax is collected by the federal government.
  • You can choose different taxpayers. In inheritance, the heirs or the deceased person's estate can pay for the tax, while in income tax it is more intuitive that only who gets the income pays.
  • You can choose different rates. You can have lower/higher rates to incentivize/penalize capital accumulation within families.

Of course, all these different rules could be integrated to income tax laws and we could call everything income tax. But since people intuitively understand the difference between regular income and inheritance, it is easier to create a new tax with an appropriate name.

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The tax has to be payable. Society won't accept a tax where many people can't receive their inheritance because of taxes.

To rebut your point about separate taxes favoring the roch and their huge inheritances, consider this. Eve actually makes 20k per year and lives in a house in poor neighbourhood with her mother. Her mother dies and the house is appraised to be worth 100k.

If those 100k were taxed just like anything else, Eve couldn't pay the tax and should sell the house to pay it. She'd end up even worse, likely renting for the rest of her life.

But society does not accept such system because they think they should be able to leave their belongings to their family after they pass away.

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    "She'd end up even worse, likely renting for the rest of her life." I kind of agree with you but just for playing devil's advocate here, renting isn't that bad. Many people do it. And the house was her mother's who only let her live there. Why should it be hers now? On the other hand it's not clear why inheritance as income must be counted in a single year. It could count as income distributed over many years for example. That would alleviate many of the mentioned problems. And finally inheritance taxes exist, she might lose the house anyway. Nov 20, 2022 at 21:41
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    Hmm. But Eve's parents, and probably Eve herself, have spent part of their income maintaining the house and garden. They have had the roof and windows replaced, installed new heating and wiring as needed. They have invested many unpaid hours. Renters will not do this. Also, Eve may already be retired herself and have a very low income.
    – RedSonja
    Nov 21, 2022 at 7:37
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    I personally think my children and grandchildren should benefit from my living sensibly. They should certainly benefit more than people whose parents spend all their income on wine, women and song. Otherwise why would I bother betting out of bed at all?
    – RedSonja
    Nov 21, 2022 at 7:41
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    @RedSonja If self-preservation is now defined as selfish, we've entered the twilight zone.
    – user2578
    Nov 21, 2022 at 19:04
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    @user253751 the taxes (or exemptions from taxes as in this case) don't have to be right or to have a logical basis. They just exist because that's what the lawmakers and voters prefer to have over the alternatives. In this case people want the ability to leave their stuff to their family more than they want to tax the rich.
    – Džuris
    Nov 22, 2022 at 1:06
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Most people don't inherit, or very little. They don't pay inheritance tax anyway.

Inheritance is a form on wealth building that is mostly used by the already wealthy family. It builds wealth along generations.

Financial power gives political power, which in turn gives political advantages.

Having a low tax rate on inheritance is maintained because rich get rich, and poor stay poor. Same thing for capital gain taxes which is lower than the highest income tax bracket in all the countries I know about.

Income tax is progressive (in most countries), and affects only low to upper-middle classes. Anyone above that receives dividends and capital gains, and doesn't pay income tax, or very little.

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  • When my parents were young, houses were cheap. People on a modest income could buy their own house. Now houses are expensive. The only way many young people can ever own their own house now is to inherit it. High taxes would take that away - anyone inheriting a house would have to sell it to pay the tax.
    – Simon B
    Nov 21, 2022 at 22:16
  • A lot of experts disagree with you. For example: "... inherited wealth isn’t a huge driver of inequality in America — it actually has had an equalizing effect. And there’s no indication that the next decades will be any different. The reason is deceptively simple: While much (much!) more money flows among the rich, for middle- and low-income people who receive gifts or inheritance, they represent a larger percentage of wealth. So large, in fact, that for some people, a gift from mom or dad is the thing that will keep them middle class."
    – user2578
    Nov 22, 2022 at 0:20
  • Source: vox. Combined with the facts that inheritance will affect approximately 25% of people, inheritances in excess of 10 million (I believe, in the USA) are taxed, so those nasty rich people are getting taxed on it.
    – user2578
    Nov 22, 2022 at 0:20
  • @SimonB So there would be more houses on the market, which should drive down prices, which would make them more affordable, which would be a good thing? I've rarely heard of people not selling the house they inherit. Many people who do inherit have already bought a home by the time they inherit from their parents, by which time they're probably in their 40s or 50s, because even without inheritance, the offspring of rich people are often rich.
    – gerrit
    Nov 22, 2022 at 8:33
  • @SimonB there would be more houses on the market and therefore prices would be lower if they could not be inherited. Children of rich parents would have to buy them with money, instead of just keeping the family mansion. Nov 22, 2022 at 12:45
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Partial answer. Philosophically, we want to be advanced beings, but actually we are still dominated by our ancient instincts. You are putting in your question the highest point of view where every member of the society is an individual and their wealth belongs only to them; passing that wealth to their children is like passing it to other individuals. But the laws are still affected by the tribal mentality; the wealth of the individual is also the wealth of the family.

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    And another ancient mentality is at work, too: Envy.
    – EvilSnack
    Nov 20, 2022 at 14:33
  • @EvilSnack are you referring to the poor homeless child being envious of the rich private school student? That indicates a real problem with society and is not just some bullshit fake instinctual thing. Nov 21, 2022 at 11:13
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    @user253751 Eliminating inheritance rights will not affect the rich private school students one bit. They'll just find themselves on a board of a trust fund with a big salary and an even bigger golden parachute, or something along the lines. It's the not-so-poor regular school students who will be at risk to go homeless once their parents die. Nov 21, 2022 at 13:38
  • @DmitryGrigoryev isn't that why it only kicks in above a certain amount? besides which, be realistic: the children are going homeless anyway because children can't rent apartments. Nov 21, 2022 at 13:40
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    No, I am referring to the ancient habit of some people who are doing okay, but are resentful that others are doing better.
    – EvilSnack
    Nov 21, 2022 at 18:32
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Keep in mind that some jurisdictions recognize the possessions of a married couple as community property (jointly owned by both) and others only recognize separate property (everything is owned by one person). If property is treated separately, then the death of one spouse means that the surviving spouse would have to pay a potentially-huge amount of taxes simply because their assets moved from one spouse's name to another. That doesn't seem fair, especially since the same property would be transferred tax-free by something like a divorce settlement, or by moving to the next state over which is a community property state. The death of a spouse is already hard enough, and forcing the widow to then sell the house in order to cover the tax consequences of losing her husband is borderline cruel. It also makes it difficult for the breadwinner of the family to ensure that their family's basic needs can still be met should something happen to them.

Also consider the traditional case of a family farm, particularly a subsistence farm. The entire family works to maintain it, and being a subsistence farm, they have practically no income. Normally, they pay no taxes on no income. Once the family patriarch dies, the survivors inherit the farm and suddenly they show a massive income that year (farms are quite valuable) and owe a whole pile of taxes. They have no real income as subsistence farmers, though, so they're forced to sell the farm and no longer have any means to support themselves. A significant fraction of the population were subsistence farmers for most of our history, so a situation like this would quickly lead to disaster. It's far better for people to remain able to provide for themselves than to end up living on government support.

It's easy to come up with a lot of situations like this where people generally agree that the consequences of taxing the inheritance as income would be undesirable. Carving out exceptions in the tax code to address these sorts of situations would get complicated very quickly, like an endless game of whack-a-mole. Instead, creating a separate estate tax that's fine-tuned to handle inheritance and nothing else is a much simpler solution that's easier to understand and implement. It also helps smooth out the differences in how each state views ownership of marital property (i.e., your federal tax burden doesn't change just because your state laws are slightly different).

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  • This is not true between spouses in the U.S. There is an exclusion from income taxes for transfers between spouses 26 U.S.C. § 1014, and both the gift tax and the estate tax have marital eductions (unlimited for citizen spouses and subject to some restrictions for non-citizen spouses if made without using a qualified domestic trust). There has never been a time in U.S. history where a subsistence farm without substantial non-farming development or mineral rights value has been valuable enough to be subject to U.S. gift and estate taxation resulting in actual taxes due. That's a myth.
    – ohwilleke
    Nov 28, 2022 at 16:09
  • @ohwilleke I'm only saying these are problems that could occur if we didn't have gift/estate taxes and inheritances were considered ordinary income. We don't see them in our current system because - as you point out - we have a separate estate tax system that ensures that they don't. I'm simply pointing out that doing it that way is significantly simpler and more efficient than shoehorning a million special cases into an already overcomplicated income tax system.
    – bta
    Nov 28, 2022 at 16:24
  • As to the differential rates, yes. But inter-spousal transfers are very often tax exempt including in the U.S. income tax system as well as for transfer taxes.
    – ohwilleke
    Nov 28, 2022 at 16:27
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Several possible reasons, which go a bit along the same lines as James K's answer:

  • Larger inheritances (which would mean higher taxation in most progressive-rate taxation systems) are linked to rich people. Rich people are powerful. They will make sure you don't get re-elected if you mess with their family's money.

  • There is competition between countries on taxes. If the taxes are too high, people may consider moving to a different country (for real or to to try to trick the taxman). Given that many countries have low or no taxes on inheritance, you don't want to frighten people off too much, or they're going to move and just not pay any taxes at all.

A few more reasons:

  • Inheritances are not necessarily cash, liquids assets, or non-productive assets. If a business is to be inherited, you usually wouldn't want the family to have to sell the business just to pay the taxes, so such assets need to be either excluded or taxed less.

  • There are a lot of different circumstances: leaving a house or flat to your partner and school-age children should not cause unnecessary burden to them, while an inheritance where the children are all adults well established in life could be taxed more. You need to have a special taxation system to (try to) take these situations into account.

  • People feel they have worked hard to "make sure their children are safe", have already paid taxes on that income. Taking money from them again can be quite sensitive.

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  • Regarding the bullet about trying to parse out whether inheritors need the inheritance, what a can of worms. I'd rather 10 people get an inheritance they don't need before we tax someone who does.--- +1 for presenting various ideas.
    – user2578
    Nov 23, 2022 at 15:57
  • "Inheritances are not necessarily cash" There have been life insurance markets to address this in eras where it has been a concern and also often payment plans or exceptions to general rules. "There are a lot of different circumstances: leaving a house or flat to your partner and school-age children" inheritance taxes with low exemptions usually make these distinctions as do laws on the priority of creditor's claims at death v. surviving family, but in jurisdictions like the U.S. where the exemptions are large, this isn't usually done (except for surviving spouses).
    – ohwilleke
    Nov 28, 2022 at 16:14
  • @ohwilleke That's really the whole point I'm trying to make: if inheritance was just income like any other, it would be difficult to carve out those exemptions, while it's a lot easier when you have separate inheritance and income taxes, with different rates, thresholds, rules, etc.
    – jcaron
    Nov 28, 2022 at 16:30
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This answer is U.S.-centric, because that is what I know best.

Why Have A Separate Gift And Inheritance Tax Regime?

There are a number of reasons to have a separate tax on donative transfers (gifts, estate, and inheritances) from the ordinary income tax. In the U.S. tax code, gifts and inheritances are exempt from income taxation pursuant to 26 U.S.C. § 102, in order to clear the field for separate gift, estate, and generation skipping transfer taxes.

One big factor is administrative convenience. It is administratively easier for tax officials to monitor the estates of people who die to see if executors and trustees are paying inheritance taxes than it is to see if members of the general public are reporting gifts and inheritances that they receive. In the U.S. system, gift tax returns historically (until quite recently) were usually audited only when someone died further streamlining the process. It also assures consistent valuation supervised by an officially deputized fiduciary chosen for their administrative competence, rather than just an ordinary individual.

Closely related is that fact that the transaction cost frictions associated with sporadic lifetime gifts from individuals interfere with the behavior people would have in the absence of taxation much more than the transaction costs associated with business transactions and employment which are typically systemic, regular, on a scale that creates administrative economies of scale, in transactions that are not "optional" and must be conducted to provide the daily needs of the taxpayer.

The justification for a certain amount of tax free gifts is similar to the income tax standard deduction in the United States that frees a large share of taxpayers from the need to keep detailed records of their daily activities.

A third issue, related to the second, is that there is a fine line between non-taxable expenditures for support of dependents and gifts, which can be better defined in the context of a gift tax. But, any inheritance or estate tax needs to be backstopped by a gift tax to avoid making lifetime gifts a huge loophole to the inheritance or estate tax system. In the case of inheritances to minors or dependent children, this blurring of lines still exists.

A fourth issue is lumping. Inheritance and atypical lifetime gifts often involve amounts that are "earned" over a lifetime, but received all at once, while most kinds of income are received gradually, and those that are not, like capital gains, often receive special treatment to address the "lumping" effect.

Why Use Different Tax Rates?

For the most part, there is no compelling reason to tax inheritances and other income at different rates, and after exemptions, the current U.S. federal estate tax rate and the current maximum federal income tax rate are reasonable similar.

Avoiding Under Taxation Of Capital Gains

One argument in the U.S. context for taxing taxable inheritances at a higher rate than taxable income, as the law did in the early 1990s is that this makes up for a shortfall in income taxation. Many (and probably most) large estate taxable estates derive most of their value from appreciation in a closely held business, appreciation in real estate, and/or appreciation in investments that accrued substantial capital gains during the owner's life that were never taxed. But, due to the "step up in basis of capital gains at death" found in 26 U.S.C. § 1014, these capital gains are never taxed in the income tax system if the owner holds onto them until death. A tax rate on estates that is higher than the tax rate on ordinary income reflects that the estate tax is a combined tax in lieu of income tax on the heirs and a make up tax on capital gains of the decedent that were never taxed in a rough justice sense.

Capital gains from investments in real estate often go untaxed in the U.S. because the capital gain proceeds can be rolled over without triggering taxation into new real estate investments pursuant to 26 U.S.C. § 1031. So, these investments are only taxed when an investor cashes out out the investment real estate sector entirely.

Income from closely held businesses (and even publicly held businesses) is often taken in the form of stock and stock options that are only taxable, again, when they are "cashed out".

And, both stock in a business and investment real estate can be borrowed against in order to avoid triggering capital gains taxation prior to death when the taxes that would otherwise be due on the accrued capital gains are forgiven.

Other countries, like Canada, tax capital gains that have accrued at death, so this isn't a consideration there.

Support v. Gifts

On the other hand, part of the justification, beyond administrative inconvenience, for taxing gifts and inheritances at rates below what would be taxed in the income tax (often zero) is that this reflects the notion that modest inheritances are part of what emotionally amounts to a duty of support which is basically a debt, owed by the older generation to younger generations, just like paying for food, clothing and shelter for children at younger ages.

Historically, the non-taxability of support for children was codified at 26 U.S.C. § 71, but that was repealed when Congress enacted Pub. L. 115-97, Sec. 11051 in 2017 which was fully effective on December 31, 2018 with some transition provisions in the interim. This is now treated as part of the definition of income for income tax purposes pursuant to 26 U.S.C. § 61, by implication since alimony and child support (including child support in kind) are omitted from transactions that constitute income, despite the fact that it is not a comprehensive list of all forms of income, and by 26 U.S.C. § 1041 which excludes from taxation transfers between spouses and transfers incident to a divorce.

Preserving Small Businesses

The tax free inheritance gap also reflects the fact that this can help preserve family farms and businesses, which are seen as socially desirable to continue.

Competing Claims To Inheritances

There is a sense that it makes sense to relieve small inheritances from taxation because they are subject to other claims.

In the U.S. context, there are two main such claimants that have some similarity to inheritance taxes.

First, in the U.S., working class and middle class people are often beneficiaries of the means-tested Medicaid program which while billed as a means-tested grant based program providing nursing home care and medical care to people who can't afford it, actually operates more like a government guaranteed loan. Medicaid keeps track of what it spends on beneficiaries and if they have enough of an estate at death to leave inheritances, Medicaid is a creditor at death with priority over heirs to the extent necessary to repay amounts advanced for nursing home care or medical care to the decedent during life.

Second, many states have costly probate systems in which the courts and executors and their lawyers receive a significant share of the estate, often on percentage of assets fee basis, in order to carry out the process of transferring assets from the decedent to the next generation.

Now, admittedly, these considerations made much more sense when the lifetime exemption from gift and inheritance taxes was $600,000 (about the 70th percentile for decedents when it was in effect due to lack of adjustment for inflation for decades)-$1,500,000 (about the 90th percentile for decedents when it was in effect) per person per lifetime, rather than $12,060,000 (about the 99th percentile for decedents today) per person per lifetime (with unused portions of the exemption inherited for use at a second death by the surviving spouse, as it is in 2022.

Gift And Estate Tax Revenues Are Modest And Wealth Is Concentrated

It is also the case that large donative transfers by gift and/or inheritance involve a much smaller tax base than earned and investment income. As currently constituted, gift and estate taxes provide only about 1% of federal tax revenues in the U.S., and since the people who are subject to the current U.S. estate tax own about 35% of the wealth in the U.S., even if all inheritances were taxed as taxable income, this tax base would still account for less than 3-4% of federal tax revenues if taxed at the roughly the same tax rates as income, while requiring taxes to be paid by about 60 times more people (about 40% of people have so little net worth and so little income that including inheritances in income wouldn't give rise to taxable income even if inheritances were taxed as income).

Reducing the exemption from $12 million per person per lifetime to $1.5 million per person per lifetime would roughly double estate tax revenues from about 1% of U.S. tax revenue to 2% of U.S. tax revenue and would require roughly ten times as many people to file estate tax returns.

Furthermore, the donative transfer tax based in much more concentrated that the income tax base, in a small number of taxpayers, because it turns out that wealth is much more concentrated than income.

Wealth inequality in the USA is even more extreme than income inequality and – like income -- it has become more unequal over time. In 1962, the wealthiest 1 percent had 125 times the wealth of a median household (Mishel et al., 2012, fig 6C). By 2010, this ratio had ballooned to 288-to-1. Between 1983 and 2010, the top 5% of wealth holders saw their wealth grow by 83%. The bottom 80% saw their wealth decline by 3.2% (Mishel et al., 2012)

In 2007, the top 1% of US wealth holders owned 35% of wealth (up from 20% in 1971).

The top 10% (including, of course, the top 1%) owned 73%. The bottom 40% of all US households owned just 4.2% of all wealth. The top 1% owns 60.6% of financial securities; the richest 10% owns 98.5% of financial securities, with the “bottom 90%” holding a mere 1.5 percent.

(Source)

So, the amount of income that can be exempt from income taxes per person without making much of a dent in tax collections and saving the people who are exempt from taxation of lot of administrative hassles for themselves and the government alike, is much smaller, than the value of inheritances that can be exempt from estate taxes per person without making much of a dent in estate tax collections (again avoiding a great deal of administrative hassles for the decedent's estate and the government alike).

A very large share of all inheritances in any given year come from people who have net worths at death in the hundreds of millions of dollars and up, so exempting mere single digit millionaires from estate taxation doesn't reduce estate tax revenues all that much despite reducing the number of estate tax returns that have to be processed and the amount of tax planning for death that middle class and upper middle class people need to pay lawyers and accountants to do, profoundly (easily reducing administrative costs by 90% or more while perhaps reducing estate tax revenues by 10% or less).

The great concentration of wealth allowing a small number of taxed individuals to provide most of the tax revenues from the taxation of gifts and inheritances also figures into the first question of why it doesn't make sense to tax gifts and inheritances as just any other kind of income.

The game of tax policy is to get as much revenue with as few complaints from the people being taxed as possible, and exempting 99% of potential taxpayers while reducing revenues collected from the transfers only modestly serves that practical policy consideration very well.

Ideology

Some critics of low taxation of inherited wealth attribute this change to "neo-liberal" policy ideologies (see, e.g., Tim Koechlin, "The Rich Get Richer: Neo-liberalism and Soaring Inequality in the United States" at pages 24-29) defined in this way (in footnote 16 at page 24):

Neoliberal “policy makers are committed to free market policies when they support the interests of big business… But these same policy makers become far less insistent on free market principles when invoking such principles might damage big business interests”.

Neoliberalism, so defined, however, does not unequivocally equate with low taxation of inheritances and neoliberalism, unlike anarchism or strict libertarianism, recognizes that some significant level taxation is necessary for a well functioning economy and society.

4
  • The point about Medicaid is interesting. Why did this consideration make more sense when the lifetime exemption was much lower? Are the Medicaid claims covered by the lifetime exemption, or do you mean Medicaid never competes with inheritance tax because nobody who has an estate en excess of the exemption would be eligible for Medicaid?
    – gerrit
    Nov 23, 2022 at 7:42
  • @gerrit The point at which Medicaid ceases to be a factor because people with greater net worth don't qualify is in the ballpark of $600K to $1500K (the value of a modest house in a high housing value area plus some retirement funds). So, refraining from imposing inheritance tax then simply respects a different program's claim. But at $12M per person per lifetime, there is a big gap between Medicaid/probate costs as a big consideration and estate tax considerations where neither apply (and capital gains tax minimization is the main goal).
    – ohwilleke
    Nov 23, 2022 at 7:46
  • I was mixed when I started on this answer. It seemed like it was headed nowhere and I was going to downvote. That changed around by the "why different rates" section, making a wash in my mind. But then this summary paragraph is really the gold in here: "The game of tax policy is to get as much revenue with as few complaints from the people being taxed as possible, and exempting 99% of potential taxpayers while reducing revenues collected from the transfers only modestly serves that practical policy consideration very well."
    – user2578
    Nov 23, 2022 at 17:05
  • I'll try reading again the first parts...
    – user2578
    Nov 23, 2022 at 17:06
3

Loophole abuse

The thing about regular tax methods, is that there are deductions you can take - for income tax, stuff like charitable donations, political donations, tax shelters, stock investments, government bonds, loans, etc.

Thing is, that's generally palatable because the income tax is meant to get the government money to provide services, sometimes towards direct services that complement the government, towards election supports, or investments into the economy.

Thing is, the leftover income from inheritance is, in part, from money already taxed, but, crucially, also applied those same deductions. And you neither want to double tax it on the previous taxes, as that would be unpopular, but...you might have reason to tax on those deductions. Since when the inheritor inherits the money, they weren't the ones who made the donations that had been exempted...and are about to inherit it now.

As a result, you, as a government, likely have more room to negotiate different ways to "Loophole" around a situation, or to put limitations on the inherited flow of money based on the fact that it has, potentially, already been deducted from taxes before.

EDIT To Add: Or as a TL:DR; Some people may had only wanted you tax money they deducted over their dead body - as a government, you get to take them up on that offer.

3

So I saved a lot of money to pay my six children's way through colleague. But unfortunately I die before they are old enough. And suddenly the tax man wants half the money that I saved for them and they will have to give up on their eduction because it's not enough money. Doesn't seem fair, does it?

BTW. The kids still live at my house and I provide for them. So not only do they lose the person putting the food on the table, they also have to pay a good percentage of the value of their home.

Another thing completely unfair with your suggestion: In most countries, rich people are supposed to pay a higher tax rate. But a $150,000 inheritance to a 20 year old doesn't make them "rich". It's just $5,000 for each of the following 30 years. So at the very least I would request that an inheritance can be paid out over time, and tax handled accordingly.

In Germany, it's quite common in wealthy families that inheritance goes to grandchildren or grand grandchildren, because that means the some money doesn't get inherited again for a very long time. A 90 year old multi-millionaire won't leave the money to his 70 year old child, or 50 year old grandchild, but his 10 year old grand grand grandchild. So the taxman doesn't get money again for 80 years hopefully.

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  • 1
    Any system in which access to education depends on the wealth of the parents is unfair. One proposal I've seen (maybe it was Piketty) was to tax inheritance and put the proceeds in a fund from which all 18-year-olds can draw to get a college education (or some other categories of spending that are deemed useful investments, like buying real estate or starting a company), not only the fortunate kids with parents who were able to save up for giving their kids better chances than other kids. Instead of Universal Basic Income one gets Universal Starter Capital.
    – gerrit
    Nov 22, 2022 at 16:53
  • @gerrit Inheritors are typically much older than 18. That idea is kind of like proposing my local tire guy pay more taxes so someone else's kids can get free college. I'm American, so I'm steeped in the property rights ideals here, but unless you're from an old communist bloc, I don't see how you can have such a cavalier approach to private property preservation.
    – user2578
    Nov 22, 2022 at 23:35
  • @frеdsbend I don't see anything wrong about your local tire guy paying more taxes to make access to education more democratic. Private property preservation when people die is impossible, because dead people can't own things. The question is merely about how to redistribute the wealth of people who have died. There's nothing communist about paying education primarily from taxes rather than charging children or their parents, unless you would call Germany and France communist. But now we're really getting off-topic here.
    – gerrit
    Nov 23, 2022 at 7:29
  • @gerrit The tire guy and everyone else already received free primary and secondary education. But then when he chooses a path that neither uses nor needs tertiary education, you believe it's fair he help pay for others who do make that choice? Yes, actually, belief that blue collars should have less property protection and more taxes to benefit explicitly not them is hallmark communism. The only this you're missing is telling him he has to work for free (for everyone's benefit, of course).
    – user2578
    Nov 23, 2022 at 15:16
  • @frеdsbend Yes, I believe it's fair that he contributes to the costs of tertiary education. If he ever visits a doctor, he benefits. If he uses a road that some engineer designed, or enters a building that some architect came up with, he benefits. If his children go to school and enjoy qualified teachers, they all benefit. And although I'm not sure what profession the "tire guy" has, manual jobs also involve (vocational) tertiary education. This is not communism. In communism there exists no state, no private property, no money, and no taxes.
    – gerrit
    Nov 23, 2022 at 16:48
3

Stability of income is probably the best argument. Consider three people Alice, Bob, and Carlos:

  • Alice has a modest income in a normal year (i.e. without any inheritance), and then in one year receives an okay inheritance
  • Bob has a large income in a normal year (i.e. without any inheritance), and then in one year receives the same inheritance
  • Carlos has the same income as Alice in a normal year, but doesn't receive any inheritance

If inheritance was taxed in exactly the same way as income, then for one year Alice's tax rate would go up massively, closer to what Bob's is. But this seems to violate two of the justifications for taxing inheritances and income:

  1. A major justification for taxing inheritances is to reduce the possibility of a wealthy elite simply reproducing themselves, arguably with negative repercussions on democracy and meritocracy. But Alice hasn't become part of the wealthy elite simply by receiving an inheritance. She will most likely go back to earning a modest income in future years. The gulf between Bob and Alice remains higher than a simplistic yearly income calculation would imply.
  2. We expect income tax to be based on some sort of ability to pay. Naturally, Alice's ability to pay has gone up compared to Carlos', but probably not as much as might be thought - she probably has bills she's able to pay off or now able to do household maintenance she'd previously put off as too expensive. Maybe she gets her first real holiday away from a stressful job in a long time. Those are all things Carlos isn't able to do... but they're also the sorts of basic quality of life things that ought to be the norm in a developed country. It's not perfect, but when we tax income there's a rough, background assumption that people's incomes year-to-year tend to be stable. Including inheritance into income tax then would mismeasure people's ability to pay, because a one-off jump in their income doesn't increase ability to pay as much as consistently earning a larger income year after year.

So basically we need to tax inheritance to some extent, but it needs to be treated differently to income because Alice is more like Carlos than Bob. And since we do still want to tax inheritances, we can still justify taxing Alice a bit more than Carlos, just not as much as an integrated system.

One final thing - I don't think the "what about the family home" arguments in other answers are particularly strong, since there are often exemptions/reductions for those sorts of things now, and there's no reason why an integrated system couldn't do a similar thing. I've focussed purely on abstracted financial wealth, as I think that's the heart of the matter.

1

At least in the United States, there isn't much choice but to create a separate category for it. Taxing it as earned income would destroy family farms and overly encourage wasteful spending near the end of people's lives. Taxing it as unearned income would be too low a tax rate for large estates.

1

Treating inheritance as income would create a huge difference between inheriting a property and (for instance) getting the same property as a gift from your parents.

People would have a choice of either gifting most of their assets to their children (perhaps using complex contracts which limit what the children can do with the assets while their parents are still alive), or penalize their children with an income tax. Furthermore, such contracts would have to be regularly updated as parents acquire new assets, and it would be especially complicated when such assets are sold or otherwise disappear. E.g. moving to a new house would become really complicated for retired people who presumably already have gifted their old house to their children.

Inheritance makes such situations more manageable, while still preserving the ability to pass wealth to the next generation within a family. Notably, the issues mentioned above essentially don't exist for rich people who have a family lawyer anyway, but would be a harsh strike for the poorer families.

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    @gerrit In U.S. law both gifts and inheritances are excluded from the definition of income. 26 USC § 102. But, while the question was not carefully stated in this regard, I think the intent was to imagine (in the U.S. context) a repeal of Section 102 which exempts both gifts and inheritances (collectively called donative transfers) from income taxation, and the repeal of gift and estate taxes, simultaneously.
    – ohwilleke
    Nov 21, 2022 at 20:14
  • 2
    @fredsbend There are gift, estate, and generation skipping transfer taxes in the U.S., but there are not income taxes on gifts and inheritances.
    – ohwilleke
    Nov 22, 2022 at 5:56
  • 1
    @gerrit, a gift is a transfer with no strings. A regularly scheduled 'gift' given in exchange for X hours per week of labor will bring an employer into an unhappy interaction with the tax authorities in the US, but I'd imagine there would be a similar skepticism applied by tax authorities to this 'gift' in most other countries as well. Nov 22, 2022 at 13:17
  • 1
    @frеdsbend To clarify, I asked why inheritance isn't taxed like other income. I was under the impression that would be the default unless there exists a special inheritance tax that exempts inheritance (or gifts) from regular income tax. After all, if the tax man asks how this €200k entered my bank account, I'd have to show them that it's inheritance and therefore not subject to income tax?
    – gerrit
    Nov 22, 2022 at 16:48
  • 1
    NB: In The Netherlands, gifts for the poorest are already essentially taxed, because if social security finds out someone bought groceries for you, they will cut your benefits. Of course, this only covers poor people, not rich or middle-class people, because rich people have lobbies and middle-class people have votes, so only the poor are penalised if they receive gifts. I would hardly be surprised if they started to penalise "someone cleaned your home for you" as well.
    – gerrit
    Nov 23, 2022 at 10:22
0

An aspect that is never mentioned when it comes to inheritance tax is that inheritance is a service offered to the heirs by the government. Real estate is recorded with the government and only exists because there is a government record of the ownership. These records need to be updated for the new owners. The tractor on the farmland belongs to the heirs because government guarantees it. Stocks lie in some banks vault. The banks must transfer the ownership to the heirs. Government obliges them to. Same for savings accounts.

One way of thinking about inheritance tax is that it is a payment for this service.

10
  • 2
    This answer rather argues for a general property tax. On the other hand, keeping that database (of who owns what) updated is probably not that expensive. The typical inheritance tax is probably much higher much beyond covering only the costs of the service. Nov 21, 2022 at 7:39
  • Software also costs more than the cost of the data transfer. Yes, a similar point of view could be taken towards a property tax (or most other taxes), but a transfer of ownership when the previous owner is dead clearly has its unique challenges.
    – tobi_s
    Nov 21, 2022 at 9:04
  • What about jewellery or rare stamps that the government does not 'manage' for you? Would your eagerness to tax extend to a Bitcoin inheritance?
    – KalleMP
    Nov 21, 2022 at 10:18
  • 1
    @Trilarion The government provides not only a database, but also a band of mercenaries (hireable thugs) that will come to your aid (for free!) if reality differs from how the database says it should be. That probably costs quite a bit. Nov 21, 2022 at 11:16
  • 1
    After writing this, I remembered an example of what happens when government doesn't take care: Swiss banks kept the assets of Jews who disappeared in the holocaust en.wikipedia.org/wiki/Volcker_Commission
    – tobi_s
    Nov 22, 2022 at 3:22
0

Hoarding wealth is how hereditary aristocracies form. It is not in the public interest of democracies to allow such aristocracies to exist. Part of why we had a revolution in 1776 was to get away from aristocracies. The simplest explanation is that such accumulation of wealth is "not fair". If you think your offspring "deserve" such money, give it to them before you die - you have plenty of time and there are plenty of ways to dodge this tax (and other taxes).

The Rule Against Perpetuities was another legal doctrine to prevent the permanent hoarding of such wealth by making it harder to transfer wealth to relatives who had not been born at the time of forming the trust. Under common law, the longest term that a trust could last was "someone alive plus 21 years" (example: your grandchild who was just born, their entire life and 21 years beyond that). Legal changes in some states, such as Florida, have replaced such restrictions and allowing trusts to last 360 years. The Rule Against Perpetuities is covered in the business law courses that accountants take. Everyone hated this subject.

Inheritance taxes do not affect the "bottom 99%" of the population of any country. Due to clever propaganda, such as using emotionally laden words such as "death tax" (this started in the 1940s), many people have been deceived to believe that they will be affected by those taxes. If you don't like inheritance taxes and don't want to pay them, then give you wealth away before you die. Our current version of inheritance taxes were legislated in 1916 (history and explanation of some of the laws involved).

The federal government has taxed inherited wealth in various ways since the nation was founded. The first time was in 1797, when lawmakers used a tax on wills and other legal documents to help pay for the nation’s “Quasi-War,” a low-grade, undeclared naval conflict with France. The second time came during the Civil War, when a new federal estate tax helped fund the Union war effort. A third time came in 1898, when the estate tax revenues helped pay for the Spanish-American War.

Source.

In the US, in 2022, you can inherit up to $12,060,000 before you pay a penny in tax (this will rise to $12,920,000 in 2023). Not all states have an inheritance tax (map showing which states have such a tax). Were you married at the time of death? Half of what you have goes directly to the spouse - that's before considering the twelve million dollars. Opponents of estate & inheritance taxes like to provoke sympathy by mentioning something like "family farm" and how it would have to be sold to pay taxes. No such thing has ever happened. When trying to identify such family farms, the closest I could find were farms where none of the inheritors wanted to "farm" - they all wanted to cash in. Additionally, "family farm" is type of corporation structure. Next time you are in the frozen food section of your grocery store, notice the frozen chicken - Tyson foods is a "family farm".

In short, you should have a will and testament before you die. If you don't, each state has a default version embedded in their laws. There is a huge industry of lawyers and CPAs who help wealthy people transfer wealth to their families in ways to avoid taxes. These are generally called "trusts". I'm all in favor of that. Do it before you die. I've met too many men who refuse to make wills because they don't want anyone to know what they have. Their widows (common refrain "he took care of everything, I don't know where any of the money is.") and children spend years trying to get stuff straightened out and none of them had enough to pay any sort of inheritance tax. Charles Dickens mocked such a situation in the novel Bleak House with a legal case called "Jarndyce v. Jarndyce". In this case, there was a huge inheritance, but legal proceedings lasted decades and legal fees ate the entire inheritance. This still happens. Especially when there aren't wills and one (or more) spouses, ex-spouses, children or others claim in legal proceedings that they deserve it, or they should have gotten it, or that they were promised it, or many other arguments for why they should get some.

5
  • 1
    "No such thing has ever happened" - I actually have family members that this has happened to, within my lifetime. It's definitely not just an abstract hypothetical.
    – bta
    Nov 22, 2022 at 18:03
  • "Hoarding wealth is how hereditary aristocracies form. It is not in the public interest of democracies to allow such aristocracies to exist. Part of why we had a revolution in 1776 was to get away from aristocracies. The simplest explanation is that such accumulation of wealth is "not fair"." That doesn't hold up. The level of freedom from what you are calling aristocracies is leaps and bounds from what the American rebels had to deal with in Europe. Money may afford you more power, usually by way of media influence, but unless you suggest cheating, it's still only 1 person, 1 vote.
    – user2578
    Nov 22, 2022 at 23:41
  • The $12M figure is on estates. An inherited estate valued over $12M at the time of the owner's death will be taxed as income on the difference. Cash, on the other hand, is passed through.
    – user2578
    Nov 22, 2022 at 23:44
  • Yeah, "No such thing has ever happened"??? No, it hasn't happened lately because it's not taxed and hasn't happened since such taxes have been disallowed. It has certainly happened in the past, and one would be a fool to suggest it won't happen if the tax was instituted again. In fact, even in comments on here, people are saying they should be made to sell it.
    – user2578
    Nov 22, 2022 at 23:48
  • In Finland if you donate you pay a tax. Also half of your estate is shared amongst your descendants even if you will other wise. If you donate to some of the descendants then it is assumed to be early-inheritance and managed accordingly. If I have two kids and donate everything to one and then die things can get complicated.
    – KalleMP
    Mar 1, 2023 at 18:29

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