Estate liabilities under inheritance tax law: deductibility and recent developments
The deductibility of Estate liabilities plays a key role in inheritance tax practice. According to Section 10 of the Inheritance Tax Act Various types of debt must be deducted from the taxable value of the estate – depending on whether they originate from the deceased, arise solely as a result of the inheritance itself, or arise subsequently in connection with the administration of the estate. A prerequisite in all cases is that economic burden of the purchaser. Current case law of the Federal Fiscal Court (BFH) clarifies and restricts the deduction in several respects.
1. Debts arising from the deceased’s estate (Section 10(5)(1) of the Inheritance Tax Act)
Debts incurred whilst the deceased was still alive may only be deducted if they existed on the date on which the tax liability arose (Section 9(1)(1) of the Inheritance Tax Act) and are attributable to the deceased. Furthermore, there must be an actual financial burden. The Federal Fiscal Court (BFH) clarifies that a debt is not to be taken into account for tax purposes if it is objectively unlikely that the creditor will ever enforce it (BFH, 24 March 1999).
This also applies to cases involving legacy payments or deferred Liabilities relating to the compulsory share, where no financial burden exists at the time of acquisition. For example, the Federal Fiscal Court (BFH) does not recognise an economic burden in the case of compulsory portion liabilities, which only become due upon the death of the heir.
In the case of care provided by the beneficiary, the decisive factor is whether a claim under the law of obligations existed against the testator. In its judgement of 22 September 1994, the Federal Fiscal Court (BFH) recognised the deductibility of such costs where a care contract for consideration existed or where such a contract could be inferred from the parties’ conduct. If the remuneration is not specified, the valuation is carried out in accordance with Section 612 of the German Civil Code (BGB).
One change in the law concerns the offsetting of the deceased’s tax refund claims against their tax liabilities in the year of death (Section 10(1), third sentence, of the Inheritance Tax Act (ErbStG)). This avoids the asymmetrical treatment resulting from the other cut-off date provisions of the Inheritance Tax Act (ErbStG). The ‘polluter pays’ principle applies to tax consultancy fees: only expenses incurred whilst the deceased was still alive may be deducted. Tax consultancy costs incurred in preparing the deceased’s income tax return are regarded as debts within the meaning of Section 10(5)(1) of the Inheritance Tax Act (ErbStG), provided they were incurred on the deceased’s initiative. By contrast, expenses incurred by the heir in connection with the correction of previous returns or the subsequent declaration of taxes evaded by the deceased are treated as estate settlement costs under Section 10(5)(3), first sentence, of the Inheritance Tax Act (ErbStG) removable.
If the heir instructs a tax adviser to clarify tax liabilities arising from the deceased’s estate, the resulting costs may also be treated as debts of the deceased under Section 10(5)(1) of the Inheritance Tax Act shall be taken into account – provided they are closely linked, in terms of both time and substance, to the acquisition of the estate upon death. In this case, they are not regarded as mere estate administration costs, even if they were only incurred as a result of a decision by the heir.
In cases where land is gifted inter vivos and is subject to a land charge, the recipient may only claim a tax deduction if they personally assume responsibility for the land charge. The mere existence of the charge is not sufficient.
2. Liabilities arising from the inheritance (section 10(5)(2) of the Inheritance Tax Act)
The liabilities of the estate arising from the inheritance include, in particular, legacies, conditions, and claims asserted in respect of the compulsory share and claims for compensation in lieu of inheritance. Their deductibility is also determined by whether they constitute a financial burden on the heir. However, it is not necessary for these claims to have been actually asserted – their legal creation alone is sufficient, for example in the case of a bequest within the meaning of. Section 1939 of the German Civil Code (BGB).
Bequests are valued differently depending on their type: monetary bequests at their nominal value, bequests of property at their tax value, and others – such as bequests of choice, bequests of a specific kind or bequests of acquisition – at their fair market value or upon the fulfilment of a condition. In the case of a so-called ‘super-bequest’, a special assessment of the encumbrance is required, particularly where the heir is required to make selection decisions. A ‘super-bequest’ refers to a testamentary arrangement in which the testator grants the heir or a third party the authority to decide which legatee is to receive which item and at what time.
Conditions are also immediately deductible, regardless of whether the beneficiary has already claimed them. The only decisive factor is that they constitute an economic burden.
Claims to a compulsory share are only subject to tax for the beneficiary once they have been asserted (Section 3(1)(1), third alternative, in conjunction with Section 9(1)(1b) of the Inheritance Tax Act (ErbStG)). For the heir, however, the liability for the compulsory share is deductible with retroactive effect from the date of death, provided that a serious claim has been made. Even if the limitation period has expired, the deduction may still be claimed if the heir has in fact satisfied the claim. A compulsory portion deferred without interest is not deductible due to the absence of a financial burden. Particular attention must be paid to the case of confusion. Confusion refers to the extinction of a debt obligation as a result of the creditor and debtor roles being held by the same person. If, in this context, the claim to the compulsory share passes to the sole heir of the person liable, the deduction remains permissible for tax purposes (Section 10(3) of the Inheritance Tax Act).
3. Costs relating to funeral arrangements, the settlement of the estate and the distribution of the estate (Section 10(5)(3) of the Inheritance Tax Act)
Section 10(5)(3) of the Inheritance Tax Act (ErbStG) identifies, as a third category, acquisition costs directly related to the inheritance. These include the costs of the funeral, an appropriate gravestone, the usual grave maintenance, and all expenses incurred in settling and distributing the estate or in acquiring the inheritance.
Funeral costs include, for example, expenses for the undertaker, transport of the deceased, the funeral service, obituaries or travel expenses for relatives. Even if the funeral is covered by insurance taken out by the deceased, a deductible claim for benefits in kind still exists (Federal Fiscal Court, 10 July 2024). Grave maintenance and memorial costs are deductible provided they are in line with local practice and commensurate with the deceased’s social status.
Other deductible costs associated with the administration of an estate include, amongst others, fees for the opening of a will, a certificate of inheritance, tracing heirs, corrections to the land register, disputes over the compulsory share, or tax advice when preparing the inheritance tax return. Executor’s fees are also deductible, provided they relate solely to the administration of the estate. However, administrative costs and ongoing administration costs are not eligible for deduction.
By contrast, costs relating solely to the administration of the estate – such as the renovation of property, debt recovery or the reallocation of estate assets – are not deductible (section 10(5)(3), third sentence, of the Inheritance Tax Act (ErbStG)). Legal costs incurred to defend against one’s own liability for inheritance tax are also subject to the prohibition on deduction under Section 10(8) of the Inheritance Tax Act.
In the case of inter vivos gifts, incidental acquisition costs are also deductible if they are closely related to the acquisition (e.g. tax advice, legal appeals, expert opinions; see H E 10.7 ErbStH).
Conclusion:
The correct treatment of estate liabilities for inheritance tax purposes requires a precise examination of the basis of the claim and the financial burden involved. In particular, recent case law and legislative changes – such as those relating to the treatment of care services, tax refunds or legacy payments made to the elderly – demonstrate that a nuanced and meticulous approach is essential in practice. At the same time, Section 10 of the Inheritance Tax Act (ErbStG) offers numerous options for structuring arrangements, which are relevant both for tax-optimised will drafting and for avoiding disproportionate tax burdens.