Inheritance Tax – Meaning, Examples, and Application

 

Inheritance Tax – Definition

Inheritance Tax is a tax imposed on the assets, money, or property that a person inherits from someone who has died.

Detailed Meaning

Inheritance Tax, also called Estate Duty in some countries, is a levy charged by the government on the transfer of wealth after the death of the owner. It applies to the total value of the estate—such as land, bank deposits, shares, jewelry, and other assets—passed on to heirs or beneficiaries.

The rate and rules for this tax vary widely between countries. In India, Inheritance Tax or Estate Duty was abolished in 1985, so no such tax currently applies. However, the value of inherited property can still have tax implications under other laws, especially Capital Gains Tax when the inherited asset is sold.

Key Points About Inheritance Tax

• Global Practice: Common in the UK, USA, Japan, and several European countries.

• India’s Status: Estate Duty abolished; only future sale of inherited assets attracts capital gains tax.

• Applicable Assets: Land, buildings, gold, stocks, fixed deposits, intellectual property, etc.

• Exemptions: Generally, personal belongings or certain small estates may be exempt in countries where it exists.

Practical Example

Example – In the UK:
If a person inherits property worth £500,000, and the tax-free threshold is £325,000, inheritance tax is applied to the remaining £175,000 at 40%.

Example – In India:
If you inherit agricultural land from your father, you don’t pay inheritance tax. But if you sell it later, you may need to pay capital gains tax based on the property’s fair market value on the date of inheritance.

Inheritance Tax in the Indian Financial System

• No Direct Tax: Since 1985, there’s no estate duty.

• Indirect Tax Impact: Selling inherited assets may lead to long-term capital gains tax liability.

• Gift Tax Rules: Property received via will is exempt from Gift Tax under Section 56(2)(x) of the Income Tax Act.

• Wealth Reporting: High-value inherited assets may need disclosure in the ITR under “Schedule AL” for certain taxpayers.

Why It’s Important

• For Estate Planning: Understanding inheritance tax helps in structuring wills and trusts.

• Tax Liability Awareness: Heirs should know how asset sales post-inheritance affect their tax position.

• Legal Compliance: Proper valuation and documentation prevent future disputes with tax authorities.

Formula for Inheritance Tax Calculation (General International Formula)

$$\text{Inheritance Tax}=(\text{Total Estate Value}-\text{Exemption Limit})\times \text{Tax Rate}$$

Journal Entry (If Inheritance Tax Exists)

(For countries with such tax)
If a business inherits assets and must pay inheritance tax:

At the time of recognizing inherited asset:

Asset A/c      Dr.      ₹XX,XXX  
   To Capital Reserve A/c          ₹XX,XXX  

At the time of paying inheritance tax:

Inheritance Tax Expense A/c   Dr.   ₹X,XXX  
   To Bank A/c                          ₹X,XXX  

(In India, this entry is generally not applicable due to no direct inheritance tax.)

Detailed Illustration – Indian Context

Suppose Mrs. Sharma inherits a residential property from her father in 2024. The property’s fair market value (FMV) is ₹80 lakh. She does not pay inheritance tax.

However, in 2026, she sells the property for ₹1.2 crore. The capital gains will be calculated as:

1. Cost of Acquisition: FMV on date of inheritance = ₹80,00,000

2. Selling Price: ₹1,20,00,000

3. Capital Gain: ₹1,20,00,000 – ₹80,00,000 = ₹40,00,000 (Indexed if applicable)

4. Tax Rate: 20% (Long-term capital gains) + applicable surcharge & cess.

Legal Implications & Real-World Use Cases

• Wills & Succession Laws: Governed by personal laws (Hindu Succession Act, Indian Succession Act, etc.).

• Stamp Duty: While inheritance tax is absent, stamp duty may apply during property mutation in some states.

• NRI Cases: NRIs inheriting property in India must follow FEMA and RBI reporting rules for repatriation.

Related Terms

• Estate Duty
• Capital Gains Tax
• Gift Tax
• Will & Succession Planning
• Probate of Will

FAQs

Q1. Does India have inheritance tax?
No. It was abolished in 1985.

Q2. Is there any tax on inherited property in India?
Not directly, but selling it later attracts capital gains tax.

Q3. Are inherited gifts taxable?
No, property received through a will is exempt under Section 56(2)(x).

Q4. Do NRIs pay inheritance tax in India?
No, but they may face taxes in their country of residence.

Q5. Can inheritance be disputed?
Yes, legal heirs can challenge wills in court under succession laws.

Expert Tip from Learn with Manika

"Even though India has no inheritance tax, smart estate planning with proper documentation ensures your heirs avoid legal disputes and optimize tax liabilities when selling inherited assets."