Private ClientsSuccession, Wealth and Foundations25.10.2022 Newsletter
Are bequests better than inheritances?
Every year, assets totalling billions of euros are transferred to the next generation in Germany. This mostly happens by inheriting.
The meaning of inheriting
"Inheriting" (“erben”) does not just mean that the heir (“Erbe”) receives something from the assets of the decedent. Rather, the heir, either alone or together with other heirs, is the testator’s so-called universal successor. In the event of death, all rights and obligations of the testator that are not of a highly personal nature automatically pass to the heir or community of heirs - the heir or community of heirs fully takes the place of the decedent. In case of a community of heirs, until the estate is divided up, each heir is entitled to a pro rata share in the entire estate and has no right to individual items of the estate.
There always has to be at least one heir. Since any debts and obligations under ongoing con-tracts are also assumed, an inheritance can be more of a disadvantage than an advantage in individual cases. Not least for this reason, heirs can opt to disclaim the inheritance.
However, even in the absence of debts, an inheritance can become a burden, for example if there are several heirs. Heirs must coordinate with each other in order to jointly manage and dis-tribute the estate. This often causes disputes. A testator should therefore always check whether a bequest (“Vermächtnis”) is sufficient to protect individual survivors.
Advantages of bequests compared to inheritances
Unlike in case of an heir, the rights and obligations of the testator do not automatically pass to the legatee of a bequest (“Vermächtnisnehmer”). The legatee does not participate proportionally in the community of heirs and cannot influence or block the distribution of the assets. Rather, the legatee has an enforceable claim against the heirs to being granted the individual bequeathed right, e.g. to payment of a certain sum of money.
However, the content of a bequest can be almost any right, which means that it is very flexible. For example, the testator may stipulate that the heir or heirs must pay the legatee a certain sum of money or hand over certain items. It is also conceivable that the legatee is granted a right of residence or usufruct, or is allowed to purchase certain items from the estate. Ongoing (pension) payments to secure the legatee are also conceivable.
A dispute over the distribution of assets can be reduced or avoided if individual persons are not designated as heirs but as legatees from the outset, i.e. are left out of the community of heirs. This has the advantage that, in case of doubt, the bequest is due immediately, whereas the distri-bution of the estate can sometimes drag on for a prolonged period. Furthermore, bequests can be used to control who should take over the family business, for example, and who should be paid out. In addition, a bequest can be subject to a condition or time limit, or can be structured as a preferential and reversionary bequest.
Tax advantages of bequests
From a tax point of view, a bequest is not disadvantageous – in fact the opposite applies. Inherited assets may trigger inheritance tax insofar as certain allowances are exceeded and tax exemptions for e.g. the family home (see our article dated (see our article dated "Immobilie geerbt: Wann keine Erbschaftsteuer anfällt") cannot be used. The same applies to the legatee. By making targeted bequests, the amount of the bequest and thus the tax burden can be precisely controlled for each beneficiary. In order to avoid a double burden of inheritance tax, the heir can deduct the bequest as a liability.
The same tax classes and allowances apply to the legatee as to heirs. As it is the testator who bequeathed the sum of money and/or property, the relationship of the legatee to the testator also applies when determining the tax class and allowances. This is an astonishing legal fiction, since the legatee only has a claim against the heir or heirs to the bequeathed sum of money or property and thus, strictly speaking, does not acquire anything from the testator. The reason for this is the intended equality of heirs and legatee(s).
An interesting factor is that a bequest can be used to distribute not only one's own assets. Ra-ther, within the framework of a so-called procurement bequest (“Verschaffungsvermächtnis”), an heir or heirs can be instructed to procure and transfer to the legatee an asset that is not part of the estate. This can also involve items that are in the assets of an heir. Assets already given to the heir can thus be redistributed by the testator. It is also conceivable for an heir to only receive the parental home, for example, in exchange for the heir giving his own acquired home to his brother or sister. Likewise, cases are conceivable in which the asset is neither part of the assets of the testator nor of the heir(s) and still has to be acquired. In this case, care must be taken to ensure that the heir sufficiently benefits from accepting the inheritance. Otherwise, there is a risk that, whilst claiming his compulsory portion, he disclaims the inheritance and thus shatters the entire succession arrangement.
From an inheritance tax point of view, the aforesaid procurement bequest is interesting because a transfer from the testator to the legatee is fundamentally assumed in such cases.
Normally, for example, the transfer of the heir's own, i.e. not inherited, assets to the legatee would be subject to the unfavourable tax class II or even III. The generous allowances for transfers between parents and children would also not apply.
With the procurement bequest, on the other hand, solely the kinship relationship between the testator and the legatee is decisive. If parents bequeath assets by way of a procurement be-quest, tax class I and an allowance of 400,000 euros per child and parent apply, even if the be-queathed item does not belong to them at all. If the bequest concerns real property of the heir, no real estate transfer tax is due on the transfer to the legatee.
Unless a misuse of the structuring alternatives has to be assumed in an individual case, assets can thus be transferred between heirs and legatees in a tax-privileged manner.