We all have to say our final goodbyes to family members or friends at some point in our life. If you were close to the person who died, you may find that they left you something in their will and testament. Before you take over your mother’s house or claim her jewelry, there’s one more item to consider: an inheritance tax on your new possessions.
What is an Inheritance Tax?
An inheritance tax is a tax imposed on assets inherited from a deceased person. The inheritance tax is paid by the person who inherits the assets, and rates vary depending on the quantity of the inheritance and the inheritor’s relationship to the deceased.
There is no federal inheritance tax in the United States, and only six states levy one: Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. Iowa enacted legislation in 2021 to phase eliminate the state inheritance tax, eventually abolishing it entirely for deaths occurring after January 1, 2025.
Inheritance tax returns and tax bills are usually due within a few months following a descendant’s death.
How is Inheritance Taxed?
If a loved one died and left you money or assets in their will, you may be wondering whether or not the inheritance is taxed. Whether or whether your inheritance is taxed is frequently determined by your state or the state of the dead individual.
The amount you owe on inheritance also fluctuates based on a variety of criteria, including:
- Size of your estate
- State tax laws
- Your relationship with the deceased person
The rate at which your inheritance is taxed is only applied to the percentage of your inheritance that exceeds the exemption level in your jurisdiction. Any inheritance exceeding those limits will be subject to inheritance taxes on a sliding system, with rates increasing as the amount inherited increases.
What is the Procedure for Calculating Inheritance Taxes?
The inheritance tax kicks in when the executor of the estate has split the assets and distributed them to the beneficiaries. The tax is calculated separately for each individual recipient, and the beneficiary is responsible for paying the tax.
A state, for example, may levy a 5% tax on all inheritances above $2 million.
As a result, if a friend leaves you $5 million in their will, you only pay tax on the first $3 million, or $150,000.
This information would have to be reported to the state on an inheritance tax form.
Which States Impose an Inheritance Tax?
There is no inheritance tax imposed by the federal government. The six states that have an inheritance tax are as follows:
- Iowa
- Kentucky
- Maryland
- Nebraska
- The state of New Jersey
- Pennsylvania
Of course, state regulations might change, so if you receive an inheritance, check with your state’s tax authorities first. The inheritance tax rate can be as little as 1% or as high as 20% of the value of the property and cash you inherit.
How Much is an Inheritance Tax?
Here’s an overview of the inheritance tax rate ranges in each state:
- Pennsylvania ranges from 0% to 15%.
- New Jersey ranges from 0% to 16%.
- Nebraska has a population of 1% to 18%.
- Maryland: 0%–10%
- Kentucky ranges from 0% to 16%.
- Iowa: 0% – 15%
From one year to the next, rates and tax rules can vary. For example, Indiana used to have an inheritance tax, but it was repealed in 2013.
State Inheritance Tax Threshold
Most states impose an inheritance tax on bequests in excess of a particular sum. The size of the estate is crucial in a few cases. As an example:
- When property passes to the recipients in Iowa, no tax is owed if the estate is worth less than $25,000.
- In Maryland, inheritances from estates worth less than $50,000 are excluded as well.
- There are further exemptions for heirs based on their relationship to the dead.
Read Also: WHAT TO DO WITH INHERITANCE: Options To Manage Your Inheritance
Here are the specifics for each state:
- Iowa: Spouses, lineal ascendants (parents, grandparents, and great-grandparents), and lineal descendants (children, stepchildren, grandkids, and great-grandchildren) are exempt in Iowa; charitable organizations are exempt up to $500. In 2022, the tax rate on others ranges from 3% to 9% of inheritance.
- Kentucky: Immediate family members (spouses, parents, children, and siblings) are exempt in Kentucky; other receivers are exempt up to $500 or $1,000. The tax is calculated on a sliding scale based on the size of the inheritance and consists of a minimum sum plus a percentage ranging from 4% to 16%.
- Maryland: Immediate family (parents, grandparents, spouses, children, grandchildren, and siblings) and charities are exempt in Maryland; other beneficiaries are exempt up to $1,000. The tax rate is set at 10%.
- Nebraska: Spouses and charities are totally exempt in Nebraska; immediate family (parents, grandparents, siblings, children, grandkids) are exempt up to $40,000 (increasing to $100,000 in 2023). Other relatives receive an exemption of up to $15,000 ($40,000 in 2023), and unrelated heirs receive an exemption of up to $10,000 ($25,000 in 2023). Prior to 2023, the additional tax rates are 1%, 13%, and 18%, respectively. These rates will climb to 1%, 11%, and 15%, respectively, beginning in 2023.
- New Jersey: Immediate family (spouse, children, parents, grandparents, grandkids) and charity organizations are exempt in New Jersey. Siblings and sons/daughters-in-law are exempt up to a maximum of $25,000. Depending on the extent of the inheritance and the familial link, the tax rate ranges from 11% to 16%.
- Pennsylvania: Spouses and small children are exempt in Pennsylvania. Exemptions are available for adult children, grandparents, and parents up to $3,500. Depending on the relationship, the tax rate is 4.5%, 12%, or 15%.
Do You Have to Pay a Federal Inheritance Tax?
Because there is no federal inheritance tax, your inheritance amount is not required to be reported to the IRS.
However, any gains from the estate between the time the individual died and the amount transferred to you must be reported and taxed on your personal tax return, according to Brian Schultz, partner at Plante Moran.
Dividends from stocks or investments you may have inherited, for example, could be considered gains.
Who is Responsible for Paying Inheritance Tax?
In most cases, spouses and charity organizations are immune from inheritance taxes. Children and other dependents or grandchildren may also be exempt, partially exempt, or pay the lowest rates.
How Much Money May You Inherit Before Paying Taxes on It?
The amount of tax is computed separately for each individual beneficiary once the executor of the estate has split the assets and distributed them to beneficiaries. Each individual must pay that tax amount and notify the state on an inheritance tax form.
There is usually a very large exemption amount for inheritance taxes, of at least $1 million, and only the amount above that barrier is taxed. As a result, according to Turbo Tax, only approximately 2% of taxpayers will ever have to pay inheritance tax.
The inheritance tax is distinct from the federal estate tax, which is levied on the total worth of a deceased person’s assets less an exclusion amount, and is normally paid out of the deceased person’s assets prior to distribution to beneficiaries. The estate pays the taxes, not the beneficiary.
Is a Cash Inheritance Taxable?
According to the IRS, cash received as an inheritance is not taxed.
However, if the money you got subsequently creates additional income–for example, if you keep it in an interest-bearing account–the additional profits may be deemed taxable income.
Whether it is taxable is determined by whether the subsequent earnings are tax-free.
If you’re confused about whether your cash inheritance is regarded to be creating additional income, a tax specialist can help you establish whether it’s exempt.
The Best Way to Avoid Having to Pay an Inheritance Tax
If you want to reduce your estate’s tax burden and maximize the inheritance your beneficiaries get, you should probably take action before you die.
Beneficiaries may not be able to reduce their expenses substantially, but they can collaborate with their descendants or relatives to determine the greatest tax-saving method for passing on their money.
#1. Give your assets away before you die.
If you believe you may face significant inheritance and estate taxes, you might consider donating part of your assets before you die. The IRS normally exempts from taxation gifts of up to $15,000 per person each year.
#2. Before dying, relocate to a distant state.
To restrict how much of your fortune goes to the government after you die, you may move to a state that does not have an inheritance or estate tax. When it comes to inheritance taxes, the state where the deceased individual lived, not the beneficiary’s residence, is important. For example, if someone in New Jersey inherits assets from someone in Montana, they do not have to pay an inheritance tax.
#3. Make use of a trust
A trust authorizes a third entity, known as a trustee, to keep and manage assets in a trust fund on behalf of a beneficiary. It enables someone to place assets in a trust while they are still alive, with control of the trust passing to a selected beneficiary after death.
Trusts are classified into two types: revocable and irrevocable. There is no official property transfer upon death under an irrevocable trust, hence there are no estate or inheritance taxes.
#4. Consult with a tax professional.
A professional can assist you in determining the best course of action for lowering your tax burden and maximizing the inheritance that you pass on to your beneficiaries.
Estate Taxes vs. Inheritance Taxes
Inheritance tax and estate tax are not the same thing. The beneficiary – the person who received the wealth — must pay inheritance tax when they get it. The estate tax is the amount deducted from a deceased person’s estate based on the worth of the estate. When someone dies, one, both, or neither of these factors may play a role.
The federal estate tax is higher than the federal inheritance tax. The federal estate tax normally applies to assets valued at more than $12.06 million in 2022 and $12.92 million in 2023, with rates ranging from 18% to 40%. Some states have estate taxes as well (see the list here), and they may have far lower exemption thresholds than the IRS. In most cases, assets inherited by spouses are not subject to inheritance tax.
Because the estate and inheritance taxes are separate, some persons may be slapped with a double whammy on occasion. Maryland, for example, has both an estate tax and an inheritance tax, which means that an estate may have to pay both the IRS and the state and then the recipients may have to pay the state again from what’s left over. This, however, is not the standard across the country.
How Much Money Can You Inherit Without Having to Pay Taxes?
The six states in the United States that have inheritance taxes allow varied exemptions based on the quantity of the inheritance and the heir’s familial relationship to the deceased. As of 2022, the federal estate tax exemption is $12.06 million (increasing to $12.92 million in 2023).3 On inheritances, there is no income tax.
What Is the Rate of Federal Inheritance Tax?
There is no federal inheritance tax, which is a tax on the total amount of assets received from a deceased person. A federal estate tax, however, applies to estates worth more than $12.06 million in 2022 (increasing to $12.92 million in 2023).3 The tax is only levied on the portion of an estate that exceeds such limits. The rate is variable, ranging from 18% to 40%.20
Do Beneficiaries Have to Pay Inheritance Taxes?
It is determined by their familial link to the deceased as well as the state in which the decedent resided or owned property. Only estates or property located in one of the six states that levy inheritance taxes may be taxed.
Surviving spouses are never subject to inheritance taxes.2 Other immediate relatives, such as the deceased’s parents, children, and siblings, are excluded to varied degrees in different states. They may be entitled to a tax-free inheritance and a lower tax rate on the remainder.
Inheritance taxes primarily affect second cousins and unrelated heirs.
How Is Inheritance Tax Determined?
The rules governing inheritance taxes differ from state to state. Most states categorize beneficiaries based on their family tie to the deceased (immediate, lineal, or unrelated), and establish exemptions and tax rates accordingly.
Most states only tax inheritances over a specified sum. They then charge a percentage of this amount, which can be flat or progressive. In Kentucky, for example, the rate ranges from 4% to 16%, increasing as the inheritance amount increases, from $1,000 to more than $200,000. It also levies a flat dollar number dependent on the inherited sum, ranging from $30 to $28,670.11
Conclusion
Only inhabitants of six states are subject to inheritance taxes. And they mostly apply to distant relatives or others who have nothing to do with the deceased. Spouses are always exempt, as are immediate family members (children, parents). Siblings, grandkids, and grandparents, if taxed at all, are given preferential treatment (bigger exemptions and lower rates).
Even so, inheritance taxes can apply to relatively minor inheritance amounts, perhaps as low as $500. Consider estate-planning methods such as donations, insurance policies, and irrevocable trusts when making bequests that may be subject to an inheritance tax.
- 7 Ways You Can Avoid Death Taxes
- WHAT TO DO WITH INHERITANCE: Options To Manage Your Inheritance
- INHERITANCE TAX: Overview & Threshold Explained
- TAXES ON INHERITANCE: What It Is & How It Works
- INHERITANCE FUNDING: What It Is And How It Works
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