What is the Inheritance Tax?

My grandfather is currently looking into ways to pass along his estate and minimize the amount his beneficiaries will have to pay in taxes. He is considering making annual gifts to his children and grandchildren to lower the amount the estate will ultimately have to pay in federal taxes. In many countries this wouldn't be as necessary since most countries use an inheritance tax instead of estate taxes.

More ideas to consider when looking at paying inheritance taxes or estate taxes include:

• Inheritance Tax. The beneficiaries of an estate pay an inheritance tax. If you are required to pay an inheritance tax, you can calculate the amount required based on the size of the inheritance and your relationship to the deceased. Eleven states still have an inheritance tax. They are: Connecticut, Indiana, Iowa, Kansas, Kentucky, Maryland, Nebraska, New Jersey, Oregon, Pennsylvania and Tennessee. In all states, you can pass your inheritance on to a spouse without paying a tax.
• Estate Tax and Gift Tax. The United States uses estate taxes instead of inheritance tax, although most people aren't affected by it. There is a standard deduction of $1.5 million and most estates are valued at less than this amount. There is a likelihood that the deduction will increase to $3.5 million in 2009. Seventeen states still have their estate taxes: Illinois, Kansas, Maine, Maryland, Massachusetts, Minnesota, Nebraska New Jersey, New York, North Carolina, Ohio, Oregon, Rhode Island, Vermont, Virginia, Wisconsin and Washington. You can avoid having your beneficiaries pay a lot in estate tax by giving gifts of up to $12,000 to an individual every year without paying federal tax on it. If you and your spouse want to make joint gifts, then this amount rises to $24,000 a year. In 2009, this amount will rise to $13,000.
• Outside the United States. Most countries use inheritance taxes rather than estate or gift taxes. In fact several countries have recently repealed their estate taxes, including Canada, Australia and New Zealand. Ireland made a change as well, utilizing an inheritance tax instead of an estate tax. The inheritance tax is also generally easier and cheaper to administer, making it more popular with several countries.

The advantage of the inheritance tax over an estate tax or gift tax is that it encourages donors to spread their wealth more widely, each recipient can claim an exemption and reduce their effective tax rate.