What Is An Inheritance Tax (Explained: All You Need To Know)

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What is an Inheritance Tax?

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What Is Inheritance Tax

Inheritance tax is a type of tax that is levied by certain tax jurisdictions on assets received by the beneficiary of an estate.

In other words, the person receiving assets following the death of another person will be required to pay inheritance tax on the assets inherited.

It’s important not to confuse inheritance tax with an estate tax.

The inheritance tax is paid by the beneficiary of the inheritance whereas estate tax is paid by the estate of the deceased.

In the United States, the federal government does not impose any inheritance taxes.

However, a few states such as Kentucky, Maryland, Iowa, Nebraska, Pennsylvania, and New Jersey may charge inheritance taxes.

Typically, the amount of inheritance tax that you’ll need to pay will depend on how much you are inheriting and your relationship with the deceased.

Keep reading as I will further break down the inheritance tax and tell you how it works.

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How Does Inheritance Tax Work

An inheritance tax is a type of tax that is paid by the person receiving an inheritance.

This is different from an estate tax that is paid by the estate of the deceased using the deceased’s assets.

As of the writing of this post, only six states in the United States have inheritance taxes: Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania.

No other state charges taxes on the amounts the beneficiary of a bequest will receive.

In most cases, the beneficiary of a bequest will have to pay taxes to the state where the deceased lived or the state where the deceased owned property.

The actual amount of inheritance taxes will depend on several variables, such as the amount the beneficiary receives in inheritance, the beneficiary’s relationship to the deceased, who passed away, and what tax law applies to the inheritance.

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How Much Inheritance Tax Must You Pay

In most states in the US, you will not be subject to inheritance taxes.

However, in Pennsylvania, New Jersey, Nebraska, Maryland, Kentucky, and Iowa, you can be charged inheritance taxes by the state.

Here are the rates that each state charges in inheritance taxes:

• Pennsylvania: 0% – 15%
• New Jersey: 0% – 16%
• Nebraska: 1% – 18%
• Maryland: 0% – 10%
• Kentucky: 0% – 16%
• Iowa: 0% – 15%

Typically, the closer you are to the deceased in a family relationship, the less inheritance tax you will need to pay.

For example, surviving spouses are exempt from inheritance taxes in all the above six states.

Only Nebraska and Pennsylvania charge inheritance taxes to the deceased’s descendants while the other states exempt them.

Also, the inheritance tax will be applied to the portion of the inheritance that is over and above the exempted portion.

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Inheritance Tax Exemptions

The states that charge inheritance taxes will levy this tax if the inheritance exceeds a certain exemption threshold.

In Iowa, the deceased’s family members are exempt from taxes and everyone else getting an inheritance will pay between 5% to 15% taxes.

In Kentucky, the immediate family of the deceased is exempt, other beneficiaries are exempt for amounts going from $500 to $1,000, and everyone else pays taxes between 4% and 16%.

In Maryland, the immediate family is tax-exempt, some beneficiaries may be exempt up to $1,000, and everyone else pays 10%.

In Nebraska, the deceased’s spouse is tax-exempt, other immediate family members are exempt up to $40,000, other relatives up to $15,000, unrelated heirs up to $10,000, and everyone else between 1%, 13%, and 18%.

In New Jersey, immediate family is tax-exempt, siblings and sons/daughters-in-law are exempt up to $25,000, and everyone else pays between 11% to 16%.

In Pennsylvania, spouses and minor children are tax exempt, adult children, parents and grandparents are exempt up to $3,500, and everyone else pays 4.5%, 12%, or 15%.

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How To Avoid Paying Inheritance Tax

There are different strategies that you can implement to avoid paying inheritance taxes or at least reduce the recipient’s overall tax liability.

If your recipients will be subject to inheritance taxes, one strategy is to purchase life insurance for the amount you wish to bequeath and designate the recipient as the beneficiary of the policy.

When the insured passes away, the insurance proceeds will not be subject to inheritance tax.

As a result, the beneficiary will receive the insurance proceeds without tax consequences.

Another strategy is to create an irrevocable trust where you transfer assets from your personal name to the trust.

Upon death, since the assets are no longer in the deceased’s name, the inheritance tax will not apply to the assets in the trust.

In the trust, you can name the beneficiaries of your choice and determine how the trust will pay them over time.

A third strategy is to simply transfer your assets during your lifetime so that your estate will have little assets or be able to make bequests below the exemption thresholds.

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Inheritance Tax vs Estate Tax

What is the difference between inheritance tax and estate tax?

Although many use the terms inheritance tax and estate tax interchangeably, they are totally different types of taxes.

An “inheritance tax” is a tax that is charged on the fair market value of assets a person receives as an inheritance.

For example, John passes away and gives $25,000 in inheritance to Mary.

If Mary is subject to a 10% inheritance tax, Mary will have to pay $2,500 on the value of her inheritance.

On the other hand, the estate tax is a type of tax that is charged to the estate on the value of the decedent’s estate.

This tax is not paid by the recipient of inheritance but by the estate directly.

In the United States, the federal government charges estate taxes if the value of the estate exceeds $12.06 million except for the decedent’s spouse.

There are also twelve states that levy estate taxes, namely Connecticut, District of Columbia, Hawaii, Illinois, Maine, Massachusetts, Maryland, New York, Oregon, Minnesota, Rhode Island, Vermont, and Washington.

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Takeaways 

So there you have it folks!

What does inheritance tax mean?

In a nutshell, an inheritance tax is a state tax that you are required to pay when you receive money or property from an estate.

The inheritance tax is charged the actual value of cash, property, or assets received and it is paid by the recipient of the inheritance.

As of the writing of this post, six states charge inheritance taxes: Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania.

Typically, the amount of taxes you are required to pay will depend on the relationship you had with the deceased and the location of where the deceased lived or property was located.

In most cases, spouses, children, and close family members may qualify for an inheritance tax exemption either in full or up to a certain threshold.

It’s important that you clearly identify which tax laws apply to your inheritance.

Now that you know what “inheritance tax” means and how it works, good luck with your research!

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