The recent Australian election included a lot of discussion about a ‘death tax’. This led to a lot of debate and confusion.
So, you might wonder, if you die, does your estate have to pay an extra tax? The short answer is ‘no’.
Death taxes, sometimes called inheritance taxes, are common in other countries such as the UK and Japan. Australia used to have an inheritance tax but abolished it in the early 1980s. This is why you still see a reference to ‘death duties’ in some Wills.
That does not mean that an estate and its beneficiaries completely free from tax consequences. There are a range of other taxes and levies that apply to assets passing to dependants or beneficiaries by way of an inheritance from a deceased estate that can feel like an inheritance tax.
Superannuation Death Benefits
Superannuation death benefits tax is a tax liability that arises as a result of the death of the policy holder so it is, in effect, a death tax.
First, some context. What you might think about as ‘your’ superannuation does not, technically, belong to you. It is held on trust for you by the trustee of the superannuation fund and is released when you reach a condition of release. Death is a condition of release.
So when someone dies as a member of a superannuation fund the trustee of that fund is obliged to release the superannuation either in accordance with a valid binding death benefit nomination or as decided by the trustee in their discretion. This is a big topic and outside the scope of this article. You can find more information here.
The people who can receive superannuation directly are anyone who meets the definition of ‘superannuation dependants’ or your estate.
If the trustee of the superannuation fund decides to pay it directly to a person who meets the definition of ‘superannuation dependent’ then the trustee will assess whether that person is a ‘death benefits dependant’. If they are, no tax is payable. If they are not, then tax will be payable.
If the trustee of the superannuation fund decides to pay it to the estate, the executor or administrator is liable for the tax and must assess whether the ultimate recipient is a tax dependant. This is a potential risk for the executor or administrator.
The definition of ‘death benefits dependant’ is similar to ‘superannuation dependent’, but is different in some critical ways.
If tax is payable is then the amount of tax that is payable can be tricky. It depends on how your fund is set up. Essentially, it is broken into a tax-free portion and a taxable portion.
The tax-free portion is never taxed when it comes out of superannuation irrespective of who it is paid to. The taxable portion is broken into the taxed element and the untaxed element. The taxed element was taxed when you paid it into super at 15%, so it is taxed coming out at 15% plus the Medicare levy.
The untaxed element was not taxed going in so it is taxed coming out at 30% plus the Medicare levy. The major variable is the proportion of your superannuation death benefits that are tax-free, taxed and untaxed.
It is incredibly important to consider who you are nominating as a beneficiary of your superannuation fund. With a bit of careful estate planning, you can minimise the tax consequences of superannuation passing to your intended beneficiaries.
Some examples will help to clarify how it works.
John is married to Jane and they have three adult children. John’s superannuation account has member balance of $500,000 and an associated life insurance benefit of $1 million.
When John dies, Jane received the whole of John’s superannuation directly. This was possible because she is a superannuation dependant. Jane did not have to pay any tax because she is a death benefits dependant.
John and Jane are divorced, and have three adult children. John’s superannuation account has member balance of $500,000 and an associated life insurance benefit of $1 million.
John nominated his children as beneficiaries under a death benefit nomination. This is a valid nomination superannuation dependants. However, they are not death benefits dependants. So, they will have to pay tax.
Assuming the tax-free portion of his member balance is $200,000, then remaining $300,000 would be taxable at up to 15% plus the Medicare levy and the insurance benefit is taxable at 30% plus the Medicare levy.
In this example, the total tax bill could reach $370,000!
Capital Gains Tax (CGT) on Inherited Assets
A person who inherits a CGT asset (such as property or shares) also inherits the relevant cost base. If a CGT asset is sold within the estate, then the CGT is payable by the estate. It follows that if you are inheriting or selling CGT assets as part of a estate, it pays to think about CGT.
CGT was introduced on 20 September 1985. Whether you will be exposed to CGT now or in the future will depend on the answers to the following questions:
- If the property was purchased by the deceased before or after 20 September 1985?
- Was the property the deceased’s main residence just before they died?
- Are you selling the property 2 years after deceased died?
- Was the property was used by the deceased to produce income?
- Are you using the property as your main residence?
- Are you using the property to produce income?
There is a handy flowchart on the ATO website where you can work out if you would be exposed to CGT.
The rules in relation to this can be complex, with specific exemptions available in some situations, so you should always consult with a qualified tax professional regarding the potential CGT impacts based on your particularly circumstances.
Taxation of Income Derived from an Estate
Any income you are entitled to as a beneficiary of an estate is assessed as normal income.
This could potentially increase the amount of income tax you need to pay. An important thing to note is that the tax on entitlement is assessed in the year the entitlement arose, rather than the tax year in which you received the income.
If you have concerns about this and know that you are going to be a beneficiary of an estate, it is important to seek expert advice regarding how it could affect your tax affairs.
It is also crucial for executors to seek legal and tax advice regarding the most effective way to distribute assets.
Estates and inheritance tax is an extremely complex topic. If you’re finding yourself lost in all the technicalities, we’re here to help. We have an expert team of estate lawyers and advisory professionals who work together to achieve the best outcome for you.