When a parent or grandparent passes away, most inheritances pass down tax free to their children. Most inherited money is not subject to sales or income tax. Granted, when the child invests the money it will be subject to whatever interest or dividends are received on the money, but the principal itself never pays taxes.

So if you are lucky enough to receive $500,000 from your grandparents upon their death, you pay no taxes on the $500,000. This unlike almost any other kind of money you may earn or receive through investments. Going forward, you will pay taxes on interest and dividends earned on that money, including unrealized dividends (those dividends immediately used to purchase more stock or bonds) either at the income tax rate or the long-term capital gains rate.

Now there is an exemption to this rule. If you inherit more then $5.49 million, you will pay an estate tax of 40% on all money received beyond the $5.49 million. In other words, the first $5.49 million you inherit is yours tax-free. That’s pretty nifty, as you get to keep all  that money to yourself without the government getting one cent of it. But then after the first tax-free $5.49 million, you have to pay 40% on any remaining inheritance.

Most Americans pay zero percent taxes on their inheritance (as they inherit less then $5.49 million). Those who inherit more then $5.49 million on average pay about 16% on their total inheritance, because the first $5.49 million is tax free. This in the grand scheme of things is a pretty good deal for those inheriting money, even millions or billions in dollars. This point can’t be said enough.

Inheritances aren’t always money. In many cases people inherit property and machinery in the form of a family business that never incorporated into a corporation rather then inheriting money. Farms are a classic example. But how many farms are there out there that are valued at more then $5.49 million dollars? Certainly that is not your rickety family farm with 80 head of beef cattle and 100 acres of rocky farm land. For liability reasons, many farms may incorporate into private businesses, so they don’t pay any estate tax between generations.

And even if they don’t, selling off an average of 16% of equipment or land to pay back the tax man is not a death blow to a family business — if your a good businessman, you can earn back whatever you had to give up when you inherited a lot of money, property, and machinery from your parents or grand parents. By any mark of fortunate, inheriting more then $5.49 million in money, machinery, land or other goods means your getting a leg up that most other people don’t get.

For most people who inherit money from their parents or grandparents, it’s not the estate tax that hits them but other taxes on yearly interest and capital gains. A $500,000 estate simply parked in a bank account that earns 1% interest, earns $5,000 a year. That is generally taxed as straight income, which is viewed by the IRS as the person making an additional $5,000 per year on top of their ordinary income from their job. So if they make $50,000 at their desk job, they have to report $55,000 a year income to the IRS, even though they aren’t utilizing any of their inheritance. They pay 10% on the first $9,275, then 15% on the portion between $9,276-$37,650, then 25% on the portion of between $37,651-$91,150. That’s how income taxes work. You income tax would be roughly $6,797 versus $5,547.

If we were really concerned about helping people invest and save for their future, the priority should not be repealing the estate taxes, but reducing taxes on investments, especially for the first few dollars gained on investment. Investments taxes, especially long-term capital gains should become more progressive so the first $100,000 or so of investment gains are not considered income but are tax free, while then taxing capital gains and income at a progressively steeper rate as more money is invested. At the same time, we should increase the Estate Tax, and lower the exemption to the Estate Tax, to discourage excessive wealth building up in specific families. People should large have to earn their own wealth, one generation at a time, and encouraged to save rather then spend more.