The crux of bequeathing or giving away assets

Claudia Neugebauer, Professor of Business Taxation at the Chair of Finance and Taxation at the University of Wuppertal, on the often perceived unfair levying of inheritance tax in Germany

First things first: Inheritance tax is levied when the deceased dies. Gift tax arises when the gift is made. From an economic point of view, it is irrelevant whether someone gives away their assets during their lifetime or only bequeaths them after their death. Under tax law, inheritance and gift are treated equally. Heirs or donees are obliged to report the inheritance/gift to the tax office within three months of becoming aware of the death of the testator or the gift. As various tax-free allowances apply, the tax office first checks the transaction internally. If the inheritance or gift is below the tax-free amount, it will no longer report it. Otherwise, the heirs or donees will be asked to submit a tax return. "The history of inheritance tax is long and it is said to have been levied as early as the Sumerian Empire. A tax comparable to today's inheritance tax was first introduced in Prussia in 1873, followed by Hamburg (1894) and Baden (1899). Inheritance law was standardised with the introduction of the German Civil Code (BGB) in 1900. In 1906, a Reich Inheritance Tax Act was enacted," explains Claudia Neugebauer, Professor of Business Taxation at the Schumpeter School of Business and Economics at the University of Wuppertal. "Initially, spouses and children were exempt from taxation. With the "Erzberger" tax reforms of 1919 and 1922, they were also subject to taxation. The tax burden within the family is reduced by granting tax-free allowances. Today, inheritance/gift tax is an integral part of the tax system. Only a few people are currently questioning the need for a tax such as inheritance and gift tax," explains Neugebauer. "It is needed so that wealthy people also contribute to financing the public budget."

The state lays claim to its citizens' money

Many heirs wonder why the state lays claim to the assets of its citizens. Neugebauer has a clear answer and says: "The question is based on a misunderstanding. It is the testator's or donor's savings that are passed on. However, inheritance/gift tax is levied on the person who receives the assets and who has not saved them themselves. This is why inheritance tax is referred to as inheritance tax and not estate tax." There are certainly situations in which the heirs/gift recipients have also supported the testator/gift giver in building up the assets by providing free help, so that they feel they have helped to build up part of the assets. "In most cases, it is also the parents who have been helped, for example when it comes to renovating or managing a property. And so the recipients often feel that inheritance tax is unfair. From a civil law perspective, however, the person who gives away the assets has built them up." The heir or donee becomes richer through the transfer of the assets and receives something that they never paid tax on before. "The perception is often different, because the parents have built up something from what they have left after deducting income tax. And the state now wants another tax on these savings," explains the expert. "However, income tax is an income tax, whereas inheritance tax is paid on the assets received. It becomes particularly problematic if the testator or donor has already paid wealth tax, because then this feeling is even more pronounced. However, the tax law assumes two different tax obligations."

Between 300 and 400 billion euros are bequeathed every year

In 2023, the state collected almost €916 billion in taxes, of which around €9.3 billion was inheritance tax. Across Germany, the tax authorities assessed asset transfers through inheritances and gifts totalling around €121.5 billion. Although €9.3 billion may initially seem like a large sum, Neugebauer immediately qualifies this and explains: "You have to differentiate, because the money does not go to the federal government. The inheritance tax goes entirely to the federal states, i.e. these 9.3 billion euros are divided between 16 federal states." There are clear differences between the federal states: richer states such as Hamburg, Bavaria and Baden-Württemberg benefit more, while poorer states such as Saxony-Anhalt, Thuringia and Saxony receive considerably less. It is striking that in 2022, around nine times as much wealth per capita was passed on in the old federal states than in the new federal states. The reasons for this lie in the past. The inhabitants of the former GDR had hardly any opportunities to build up wealth. "A large part of the inherited wealth still consists of property," says Neugebauer, "and many people in the former GDR didn't have that. Only today's generation can build up wealth, but this will only be inherited by the next generation."

The unequal distribution of inheritance tax has an impact on state budgets. "In the tax area, we sometimes say somewhat heretically that we are dying for education. This is because inheritance tax is a state tax and the state is responsible for financing education. It is therefore in the interest of the federal states to generate high tax revenues in order to be able to finance universities and schools."

Tax allowances for inheritances and gifts

Assets are often passed on between generations, i.e. from parents to children or between spouses. In order to minimise the tax burden here, the Inheritance and Gift Tax Act provides for allowances on the one hand and a lower tax rate on the other. Neugebauer: "The tax-free amount for spouses is 500,000 euros, for example, and 400,000 euros for children. In addition, a pension allowance can be claimed in certain cases." Prior to the transfer, it should be checked whether the asset situation is correctly presented. If, for example, one spouse inherits a flat or house and extensive renovations or extensions or conversions are carried out later, the lending bank often requires both partners to sign the loan agreement. "In this situation, only a few spouses go to the notary beforehand to transfer a share of the property to the jointly liable partner. If the legal owner of the house then dies, the partner inherits the share that he or she helped to build up." In the case of children, the tax-free amounts also apply per parent. If both parents have assets, an amount of up to €800,00 can be transferred tax-free to the children. The tax-free allowance can be claimed again after ten years. This can mean that assets are not given away in one transaction, but spread over several decades. The extent to which parents wish to pass on property they have already used themselves during their lifetime to the next generation must be carefully considered. As a notarised deed of gift is required when transferring real estate, both a right of residence for the parents and a right of retransfer can be agreed.

Business assets are taxed at a lower rate

"In family businesses, the assets are often tied up in the company. If inheritance tax is due here, some of the business assets may have to be sold in order to pay off the tax liability," says Neugebauer. This can be problematic for the company, especially in difficult economic times. "In the current situation, we are seeing this with suppliers in the automotive industry, for example, which is weakening. Many of these companies are family-run. Inheritance in such a situation of economic upheaval can pose a problem for the company. After all, assets are not the same as liquidity." "We know the case of Thurn und Taxis from Bavaria. After the death of Johannes von Thurn und Taxis in 1990, around DM 50 million in taxes had to be paid. The estate consisted largely of forests, castles and valuable pieces of jewellery and antiques. Almost half of the tax debt was paid through the sale of jewellery and furnishings. The rest was paid by transferring furniture, books and works of art to the state of Bavaria." In the meantime, special exemption regulations apply to works of art, etc.

However, we also have family businesses where the rules are such that the heirs cannot freely dispose of the inherited assets. This is because the company always comes first. So in the event of inheritance, you have a large amount of assets, but not the opportunity to sell them. The legislator has provided tax exemptions for this, which are linked to various conditions. Ultimately, this can lead to the following situation: "The more assets I have, the lower the inheritance tax." It therefore depends heavily on how the assets are tied up. As a result, those with medium assets are often more likely to be subject to tax than those with large assets. In some cases, the tax due can be deferred. If these regulations do not apply, the only option is often to sell or encumber part of the transferred assets in order to settle the tax liability.

Who inherits the debts?

In the case of houses, the location always plays a role and if the deceased has lived in the building for 40 years without any major renovations, it must first be reinvested in. In the case of distant relatives with a low tax-free allowance and the uncertainty of who else might be entitled to inherit, it is not necessarily worthwhile to accept an inheritance. In addition, inheriting does not always mean coming into a debt-free estate. Neugebauer explains: "If it turns out that the property is in debt, you can renounce the inheritance and the inheritance, along with the debts, goes to the next person in the line of succession. If no one succeeds, the state inherits in the end." A person entitled to inherit generally has six weeks from the time they become aware of the inheritance to decide whether or not to accept the inheritance. If someone accepts the inheritance, they legally follow in the "footsteps" of the deceased. The heir is also liable for the testator's debts with their own assets. To avoid this, it may make sense to apply for insolvency proceedings against the estate. This limits liability to the estate and the heir's own assets are no longer liable.

Inheritance tax-free foreign countries

It may be hard to believe, but there are actually countries in Europe that have never, or no longer, levy inheritance tax. These include Malta, Romania, Sweden, Cyprus and, since 2008, Austria. "They had the same problem as us with wealth tax. After a successful lawsuit against the assessment basis for property, inheritance tax was completely cancelled there," says Neugebauer. In general, however, it is difficult to compare the tax conditions of the countries, as the social systems are structured differently and other benefits are also granted. "In the Netherlands, inheritances are taxed quite heavily. Care in nursing homes there is organised in such a way that an income-based co-payment has to be paid, but no recourse is made to savings, assets or dependants. "

Tax advisors provide information

"The discussion about inheritance and gift tax is usually very emotional," says Neugebauer. The tax due on the transfer of assets can be legally optimised. However, the prerequisite is that assets are transferred, i.e. the donor must be prepared to give up their property. Tax advisors could be a first port of call for comprehensive information. "The valuation of business assets is particularly challenging. The way in which inheritance and gift tax is levied is currently being criticised. Due to the payroll period of five or seven years, it is a difficult type of tax to calculate, especially for companies in difficult economic times. In science, we would actually favour an inheritance and gift tax with a broader assessment basis combined with a lower tax rate," concludes Neugebauer, "so that it is easier to calculate and deal with. This would make it more predictable and would not trigger an additional tax burden in economically difficult situations."

Uwe Blass

Prof Dr Claudia Neugebauer works at the Chair of Finance and Taxation in the Schumpeter School of Business and Economics at the University of Wuppertal.