Estate liabilities, inheritance tax & structuring opportunities

Estate liabilities reduce the inheritance tax burden for heirs. When applied strategically and drafted with precision, instruments such as bequests or conditions in a will can be used to deliberately lower the tax liability of future heirs.
This article focuses exclusively on the inheritance tax perspective.

Estate liabilities and inheritance tax

When it comes to inheritance tax, it is important to know that not all inherited assets are automatically subject to taxation.

When calculating the amount of inheritance tax, the value of the estate is the determining factor.
In a first step, the value of the assets at the time of death is assessed. In a second step, estate liabilities – meaning all debts and costs related to the inheritance – are identified and deducted from the asset value.

This is stipulated in Section 10 (5) of the German Inheritance and Gift Tax Act (ErbStG).
As a result, estate liabilities reduce the taxable value of the estate – and therefore indirectly lower the inheritance tax payable by the heirs, provided their personal tax allowances have been exceeded.

There are three main categories of estate liabilities:

• Debts of the deceased: liabilities incurred by the deceased during their lifetime that form part of the estate
• Succession-related obligations: liabilities triggered by the inheritance itself, such as bequests, conditions imposed by the will, or compulsory share claims
• Estate administration costs: expenses related to settling the estate, such as funeral costs, legal and tax advisor fees, court fees, probate certificate proceedings, etc.

When examining the different types of estate liabilities, one thing becomes clear:
Succession-related obligations (Erbfallschulden) can be influenced by the deceased, for example by including specific provisions in a will – ranging from bequests or conditions to strategic disinheritance, such as in the case of a Berlin will (Berliner Testament).

What Counts as Estate Liabilities?

But what types of estate liabilities are there – and what effect do they have?

Debts of the deceased

So-called debts of the deceased include all outstanding liabilities incurred by the deceased, such as unpaid invoices, outstanding loans, or tax debts.

In order for these debts to be taken into account when calculating the value of the estate, it is essential that the liability arose – or was at least initiated – before the death of the deceased.

Important:
Purely moral obligations are not sufficient. Even if heirs voluntarily settle a debt (e.g. a claim that is time-barred), this will not be taken into account when calculating the value of the estate.

Conditions and Compulsory Shares as Succession-Related Liabilities

Conditions and asserted claims to compulsory portions arise as succession-related liabilities – unlike debts of the deceased, they only come into existence upon the occurrence of the inheritance.
They are also considered estate liabilities and reduce the taxable value of the estate.

Conditions

Conditions are obligations imposed by the deceased on the heirs.
These may include, for example, the duty to maintain a grave or to make specific purpose-related payments (e.g. providing financial support to a certain individual or donating certain amounts to charitable causes).
The costs arising from such conditions are deductible and therefore reduce the taxable value of the estate.

Asserted claims to compulsory portions

Compulsory share claims made by disinherited statutory heirs also count as deductible estate liabilities.
Disinheritance plays a greater role than one might initially think. For example, in the case of a so-called “Berlin will” (Berliner Testament), where spouses appoint each other as sole heirs, the children are effectively disinherited in the first stage of succession.

However, for compulsory share claims to be recognised as estate liabilities, they must have been asserted.
The timing of this assertion is crucial when calculating inheritance tax.
If necessary, an inheritance tax assessment that has already been issued must be adjusted retroactively.

Bequests as Succession-Related Liabilities

Bequests are also considered estate liabilities – specifically, succession-related liabilities.

Bequests are a commonly used tool to actively structure the estate and its value.
A bequest is a provision in a will that grants a specific asset (e.g. cash, property, etc.) to a named individual without appointing that person as an heir.
This means that the beneficiary of a bequest has only a legal claim against the heirs to receive the item in question. They do not become part of the community of heirs – unless they have also been named as a co-heir.

As such, beneficiaries of a bequest are creditors of the heirs – and depending on the type of bequest, they may have substantial claims against the heirs.

It is often difficult to distinguish between a bequest and a division directive in a will. However, this distinction can have significant legal consequences.
Read more in our article: “Division Directive vs. Preferential Bequest”.

Whether the bequest involves money or specific assets is irrelevant for the calculation of the estate’s value. Only the value of the bequest itself is decisive. Unlike compulsory share claims, a bequest does not necessarily have to be asserted in order to be recognised as an estate liability for inheritance tax purposes. Even if the heirs fulfil the bequest voluntarily — without a legal obligation (e.g. in the case of a formally invalid bequest) — it may still be possible to deduct the value as an estate liability.

Note:
The so-called “super-bequest” (Supervermächtnis) is a highly flexible estate planning tool. It allows heirs (e.g. a surviving spouse) to decide after the testator’s death whether — and what — a designated beneficiary (e.g. a grandchild) should actually receive.

This can be used to make optimal use of tax allowances — such as those available to grandchildren — and to relieve heirs of tax burdens

However, the wording must be extremely precise for a super-bequest to be recognised for tax purposes. There are many potential pitfalls in the drafting.

Estate liabilities and succession-related debts offer tax-saving potential!

Estate liabilities and succession-related debts are an important lever for tax optimisation and should not be overlooked in active estate planning.
With the right structuring, they can provide clarity, lead to fair outcomes, and at the same time reduce the tax burden on heirs.

Conditions, strategic disinheritance and especially bequests offer significant potential in this context.
In certain cases, even intra-family loans granted during the testator’s lifetime can have a positive effect on inheritance tax – provided that a loan liability remains within the estate.

Professional advice and careful drafting of wills is essential

However, it is essential in all cases to carefully determine which structuring options are appropriate for the specific situation.

Equally important is the precise wording in the will itself,
to ensure that the provisions hold up under tax scrutiny and lead to a tax-efficient outcome.
In both aspects, I am happy to support you in finding the best possible solution for your estate.

Frequently asked questions on estate liabilities and inheritance tax

Which estate liabilities reduce inheritance tax?

All estate liabilities reduce the value of the estate and thus indirectly lower the inheritance tax.
Estate liabilities include:

• Debts of the deceased (e.g. loans, unpaid bills),
• Succession-related liabilities (e.g. bequests, conditions, compulsory share claims) and
• Estate administration costs (e.g. funeral expenses, legal and court fees).

They are deducted from the total value of the estate and thus reduce the taxable estate, which serves as the basis for calculating inheritance tax.

Can bequests be used strategically to optimise inheritance tax?

Yes. Bequests – along with other estate liabilities – can be used strategically to reduce the value of the estate and thus lower the inheritance tax burden for the heirs.
Bequests are considered succession-related liabilities, which decrease the taxable estate.

One particularly flexible option is the super-bequest, which allows heirs to decide, after the testator’s death, on the scope of the bequest and who should benefit from it.

What is required for estate liabilities to be recognised for tax purposes?

This depends on several factors:

• For debts of the deceased, it is essential that the liabilities actually arose before the testator’s death.
• Compulsory share claims must be asserted against the heirs in order to be taken into account, whereas bequest claims do not require such assertion.
• In the case of succession-related liabilities that are actively structured — such as bequests — it is crucial that the provisions are clearly and unambiguously stated in the will.

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