Death is one of the unavoidable realities of life, yet we often put off thinking about it as a “future problem”. But what happens if you die unexpectedly without doing any estate or inheritance tax planning? In Japan, this could leave your loved ones with a hefty tax liability, reducing the value of the assets and investments that you have worked hard to accumulate. That’s why it’s important to calculate inheritance tax in Japan ahead of time and plan accordingly.
Death And Taxes In Japan: Estate Tax Vs. Inheritance Tax
Estate tax and inheritance tax are both categorized under the broad umbrella of “death tax” (i.e. a tax that applies when an individual passes away). These two taxation systems pertain to the transfer of wealth and assets after an individual’s death. However, there are key differences between the two, including:
- -Timing of Taxation: Estate tax is imposed on the entire estate (the total value of a deceased person’s assets) before it is passed on to the beneficiaries (those who will receive the assets). In contrast, inheritance tax is imposed upon the transfer of assets from the deceased to their beneficiaries.
- -Beneficiary’s Responsibility: Estate tax is paid by the estate itself. Beneficiaries typically don’t have a direct obligation to pay estate tax. Instead, the estate itself settles the tax liability from its assets before distribution. With inheritance tax, however, the beneficiaries are directly responsible for paying inheritance tax on the assets they receive.
Most countries follow one or the other (although some countries do not impose a “death tax” at all). Japan follows an inheritance tax system (called “sōzokuzei”, 相続税), which means that it taxes individuals who inherit money or property from someone who has passed away. Here are some key aspects of Japan’s inheritance tax system:
- -Progressive Tax Rates: Japan’s inheritance tax rates are among the highest globally, and they follow a progressive structure. As the value of inherited assets increases, tax rates escalate accordingly. Larger inheritances are subject to higher tax brackets, potentially placing significant tax burdens on beneficiaries.
- -Inclusive Coverage: Japan’s inheritance tax laws encompass a wide range of inherited assets, including financial assets, property, and personal belongings. The tax is also imposed on worldwide assets if either the deceased or the inheritor has been a resident in Japan for 10 out of the last 15 years.
- -Special Benefits and Living Gifts: Japanese law considers certain gifts that are given during a person’s life as “living gifts“ or “special benefits.” These are seen as advance transfers of one’s inheritance. When the time comes to divide the inheritance after the individual’s death, these “living gifts” are factored into the calculation of the inherited assets, affecting the overall tax liability of beneficiaries.
Division Of Assets: Statutory Vs. Will-Based Inheritance Law In Japan
Knowing how assets will be distributed amongst the heirs will help determine how much inheritance tax will apply to each heir’s portion. The distribution of a deceased person’s assets can occur through either a will-based inheritance or what is called “statutory inheritance”. Statutory inheritance acts as the default when there is no legally valid will in place to designate the division of the deceased person’s assets. These two systems govern how assets are divided among legal heirs and non-legal heirs. Here’s how they work:
- -Statutory Inheritance: Statutory inheritance comes into play when there is no legally valid will to guide asset distribution. In this case, the government’s default plan, as outlined in Japanese law, takes effect. Statutory inheritance follows a structured hierarchy of legal heirs (called houtei souzoku nin, 法定相続人) based on their relationship to the deceased. The legal heirs are defined and ranked as follows:
- 1. Spouse: The spouse is always considered a legal heir in Japan, and they have a statutory entitlement to at least 50% of the assets.
- 2. Children/Grandchildren: If a child has passed away, their children (the deceased’s grandchildren) become the heirs.
- 3. Parents/Grandparents: If both parents and grandparents are alive, parents become the legal heirs. If only grandparents are alive, they inherit.
- 4. Siblings, Nephews, and Nieces: Inheritance can only pass to nephews and nieces if the sibling has passed away.
- According to statutory inheritance law in Japan, those who are not considered legal heirs (such as step-children or common-law partners) have no legal claim to any portion of the inheritance. However, inheritance portions can be adjusted or shared should all legal heirs agree to do so.
- -Will-Based Inheritance: In a will-based inheritance, the deceased individual’s will specifies how their assets are to be distributed. This allows for a more personalized and flexible approach to asset allocation, departing from the default statutory inheritance rules. In Japan, however, certain legal heirs are guaranteed a percentage of an inheritance regardless of the dictates of a legal will. For instance, if the remaining heirs include a spouse or children, these heirs are entitled to at least 1/2 of the estate, with this value divided among them.
Calculating Inheritance Tax in Japan
Japan’s inheritance tax rates follow a progressive structure, which means that as the total value of inherited assets increases, the tax rate also increases. This system places a higher tax burden on larger inheritances. In essence, the more wealth and assets an individual inherits, the more they will be taxed on those assets after the tax-free threshold, as follows:
- -Up to 10 million JPY: 10% of the total value is taxed.
- -Above 10 million JPY and up to 30 million JPY: 15% of the amount exceeding 10 million JPY is taxed.
- -Above 30 million JPY and up to 50 million JPY: 20% of the amount exceeding 30 million JPY is taxed.
- -Above 50 million JPY and up to 100 million JPY: 30% of the amount exceeding 50 million JPY is taxed.
- -Above 100 million JPY and up to 200 million JPY: 40% of the amount exceeding 100 million JPY is taxed.
- -Above 200 million JPY: 55% of the amount exceeding 200 million JPY is taxed.
Inheritance tax is applied to and paid by each individual heir. As such, the amount of inheritance tax paid will differ from person to person based on the portion of inheritance assets that they receive and the deductions that apply to them.
The Step-By-Step Process: A Working Example Of Japanese Inheritance Tax
Let’s say that David wants to understand how much his wife, Keiko, and his two beloved daughters, Hana and Ema, would have to pay in inheritance tax after his death. Over his working years, David has accrued a substantial amount of wealth in various assets. However, he realizes that in Japan, substantial assets can turn into substantial liabilities when transferred as inheritance or gifts. He decides to work with a financial adviser in order to anticipate and mitigate the burden on his family. Together, they take the following steps:
Step 1: Determine the “Gross Asset Value” of David’s estate.
“Gross asset value” refers to the total value of David’s combined assets. These assets (called zaisan, 財産) include all property and financial assets – even life insurance payouts. In essence, anything that can be assigned monetary value is considered taxable inheritance under Japanese law.
Taking into account the market value of all of David’s assets, David and his financial adviser determine the gross asset value of his property to be 330,000,000 JPY.
Step 2: Subtract liabilities, expenses, and exemptions to find the total taxable value.
Next, David and his adviser assess outstanding liabilities like debts, loans, and mortgages. They also take into account expenses that would be associated with David’s death, such as the funeral. They also calculate tax exemptions. These include:
- Donations to the Japanese government and local ward office
- Certified NPO donations
- The first 5,000,000 JPY of any life insurance payouts and severance pay per inheriting heir
After factoring in deductions, expenses, and exemptions, David and his adviser find the total taxable asset value to be 230,000,000 JPY.
Step 3: Subtract the basic deduction from the total taxable asset value.
After determining the total taxable value of David’s assets, David and his adviser calculate and subtract the basic inheritance tax deduction to determine the net taxable value. This deduction consisted of a standard 30,000,000 JPY plus an additional 6,000,000 JPY for each legal heir — in this case, Keiko, Hana, and Ema.
- Net Taxable Value: Total Taxable Value – [30,000,000 JPY + (6,000,000 JPY × 3 people)] = Net Taxable Value
- 230,000,000 – 48,000,000 JPY = 182,000,000 JPY
With the net taxable value of David’s assets determined, they move on to break down each heir’s taxable inheritance portion. According to Japan’s statutory inheritance law, Keiko will receive half of the inheritance, while Hana and Ema each receive one-quarter of the inheritance.
- Keiko’s taxable inheritance: 182,000,000 JPY x ½ = 91,000,000 JPY
- Hana’s taxable inheritance: 182,000,000 JPY x ¼ = 45,500,000 JPY
- Ema’s taxable inheritance: 182,000,000 JPY x ¼ = 45,500,000 JPY
Step 4: Apply the appropriate inheritance tax rate to determine individual tax liability.
Next, David and his adviser calculate the tax liability of each of David’s heirs. According to the graduated tax rate, they determine the liabilities as follows:
- Keiko’s inheritance tax liability: 91,000,000 JPY x 30% = 27,300,000 JPY
- Hana’s inheritance tax liability: 45,500,000 JPY x 20% = 9,100,000 JPY
- Ema’s inheritance tax liability: 45,500,000 JPY x 20 % = 9,100,000 JPY
Step 5: Determine if the spouse exemption applies and adjust accordingly
Much to David’s surprise, there is a possibility that Keiko may be exempt from paying inheritance tax at all. This exemption applies to total taxable assets that would attract a marginal tax cost of up to 160,000,000 JPY (i.e. a tax credit of 160,000,000 JPY) or half of Keiko’s guaranteed statutory share – whichever is higher. In Keiko’s case, her total taxable asset value comes to 105,000,000 (half of the overall taxable asset value), so she is exempt from paying inheritance tax.
At this point, the calculations are almost finished. David’s financial adviser informs him that they will have to recalculate Hana and Ema’s inheritance tax liability based on the overall inheritance tax liability. Each will have to pay one-quarter of the total:
- Total inheritance tax liability: 45,500,000 (27,300,000 JPY + 9,100,000 JPY + 9,100,000 JPY)
- Hana’s final inheritance tax liability: 45,000,000 x ¼ = 11,375,000 JPY
- Ema’s final inheritance tax liability: 45,000,000 x ¼ = 11,375,000 JPY
Protecting Your Heirs From Inheritance Tax
As you have seen, inheritance tax can add up quite quickly when you have substantial assets to pass on. Fortunately, there are ways that you can protect your loved ones from tax liability after your death using basic tax planning techniques. Of course, your ideal plan will depend on your individual circumstances – such as where your assets are housed and what investment and tax planning options you have available to you. Whatever your unique situation, an experienced financial adviser can help you navigate your options and come up with a personalized strategy that fits your needs. Don’t let the wealth you’ve worked so hard to earn fall prey to inheritance tax. Speak to a professional to protect your assets and ensure financial stability for your loved ones.