How do countries tax inheritance?

Every country collects taxes. But, this one tax has different rules for different countries. How? Read on.

Taxes drive a nation. And, government authorities keep looking for ways to increase this revenue without hampering the growth. They take bites from every transaction that benefits a person. Whether you earn salary or make gains in a business, you pay tax. Whether you earn commission or earn rent, you pay tax. This basic rule governs taxes across all countries. But, there is one transaction where different countries seem to have different opinions.

Inheritance.

What should be done when an individual’s property is passed on to their family members?

The U.S, South Korea and India, all have very different ways to deal with this.

South Korea has the highest inheritance tax rates. It ranges between 50-60% of the value of assets inherited and has to be paid within 6 months of inheritance. In fact, just recently, the Samsung family had to pay taxes going as high as $10.8 bn, in order to inherit the property left behind by the Samsung group’s chairman, Lee Kun-hee.

Sounds cruel. A person cannot pass on their hard earned money to their children without being taxed. But at the same time, the state benefits. A more equitable distribution of wealth is made possible.

Now, let’s explore the other end of the spectrum. The United States, where an “angel of death” loophole or ‘step-up in basis tax provision’ leads to zero taxation on inheritance. 

Aaah. Exciting. Here’s what the loophole is about.

Meet Sam and his family. The year is 1990. Sam retires from his corporate job and purchases a farm for $10,000. 

Now, fast forward to the year 2010. Sam is old and dies peacefully, passing the farm to his daughter, Mary. The farm is now worth $1,00,000 and Mary is not required to pay any tax while inheriting the property. But after a couple of years, Mary wants to move to another city and decides to sell the farm. By then, the value of the farm goes up to $1,20,000. 

Now, as per the U.S laws, Mary has to pay tax on gains of $20,000 ($1,20,000 - $1,00,000) only. 

Did you see what just happened here?

The gains made by Sam of $90,000 ($1,00,000 - $10,000) were not taxed at all!

And, the rich people benefit the most from this law. Under the current law, heirs of Jeff Bezos will get off the hook from paying $36 bn worth of taxes. In fact, this law costs the government $43 bn every year. 

Result? 

The rich get richer, and the development of the country gets hampered.

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Now, let’s see something that falls somewhere in between the two extremes of South Korea and the U.S.

The Indian Tax Laws.

If Sam and Mary were in India, Mary would not be charged with a hefty inheritance tax after Sam’s death. 

Instead, when she sells the land for $1,20,000, she will be required to pay tax on the gains made by her father too. i.e, $1,20,000 - $10,000 = $1,10,000 (to all the CA friends, sorry for grossly simplifying. Yes, taxes will be calculated after indexation or after making adjustments for inflation).

Thus, Mary is not overburdened with taxes at the time of inheritance. And well, technically, the entire amount is a gain for her as she got it by virtue of birth so she ought to pay up. 

And, what about the government? Sure, the collection is delayed, but it is not robbed of its fair share of revenue.

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Well, Joe Biden is now looking to plug the angel of death loophole in the U.S. What do you think of the move? And, which approach do you like? Let us know in the comments!

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ReadOn Explains: Wealth tax is not the same as inheritance tax. Wealth tax is paid by you basis your net wealth while you're living, and inheritance tax is paid by your heirs when they inherit your wealth after you're dead.

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