Imagine getting great news that you received a large inheritance from a long-lost relative.
Imagine now getting the bad news that you might owe a hefty inheritance tax on that money or property you just received.
Depending on where the deceased person lived, you might have to pay taxes on your inheritance.
The tax rate and total amount you owe depend on a few factors. In this article, we will discuss everything you need to know about the inheritance tax.
If you are named in someone’s will, you will fully understand the tax implications of the inheritance and be prepared to handle it appropriately.
What Is An Inheritance Tax?
An inheritance tax is a tax on any assets that you receive as an inheritance from a decedent’s estate.
You might also hear this referred to as the death tax, but there are two different taxes.
You might receive the inheritance in a couple of different ways.
- Perhaps the decedent specifically listed you in the will as an heir and maybe even described the specific property or assets you were to receive.
- Alternatively, the deceased person may not have had a will at all. The intestate succession laws of the state where the deceased lived might say that you will receive an inheritance based on your relationship with the deceased.
Either way, the inheritance you receive might be taxable.
Inheritance taxes are paid at the state level. There is no federal inheritance tax. There are federal estate taxes, which will be discussed in the next section of this article.
Some states require the payment of inheritance taxes, while others do not. So, you might get lucky and inherit assets from a state with no inheritance tax.
This means you will receive that inheritance tax-free, regardless of how large the inheritance might be! If the deceased lived in a state that does require the payment of inheritance taxes, then you must claim your inheritance on your state tax return.
When it comes time to pay your income taxes for the year, you must also pay up for any taxes due on the inheritance you received.
KEY TAKEAWAYS
- You may be subject to state inheritance tax if you receive an inheritance. Certain states may tax the beneficiary directly for any inheritance (property, asset, cash, etc).
- Inheritance tax differs from estate/death tax, but there are estate planning strategies that can help you eliminate or reduce both taxes.
- There is no federal inheritance tax!
Difference Between Inheritance Tax And Estate Tax
One of the main goals of estate planning is to reduce the amount of taxes that will be due as much as possible.
So, what is the difference between estate and inheritance taxes? These two things sound very similar but are entirely separate and different. Here are the basics.
Estate Taxes
- Certain estates may be subject to federal estate taxes.
- The IRS calculates and collects federal estate tax, while Congress sets the estate tax rates and exemption levels.
- With estate taxes, the deceased’s estate is treated as its own legal entity. The estate must obtain a Federal tax identification number and file tax returns.
- Estate taxes are calculated at the estate level. All the estate’s assets are added together to obtain the estate’s total value. Once the estate tax exemption has been subtracted, then taxes are due on the remainder of the taxable estate.
- The estate’s value is established as of the person’s death date.
Inheritance Taxes
- There are NO inheritance taxes at the federal level.
- Established at the state level, each state will calculate the tax on your inheritance.
- Only Iowa, Kentucky, Nebraska, New Jersey, and Pennsylvania levy an inheritance tax.
- With an inheritance tax, each beneficiary must claim the inheritance on their tax return and pay any applicable taxes.
For example, if you and your brother each receive a $10,000 inheritance from a grandparent, then you would each claim that $10,000 on your individual income tax returns with your state while there would be no need to include it on your federal income tax return.
*The reporting on your tax forms needs to occur in the year you received the inheritance.
- An inheritance tax calculates the tax on an individual beneficiary basis. Regardless of the size of the overall estate, you are only responsible for paying taxes on the amount of the inheritance that you received.
- Another critical factor to remember is that the inheritance tax due is calculated on the market value of the assets when they are distributed to the beneficiary (not at the date of death).
If the value of those assets increases, you might be responsible for additional taxes later. This could include capital gains taxes.
For instance, suppose your mother died and left you with mutual funds valued at $50,000. You decide to sell the funds a year later, and they are then valued at $75,000. You will likely be responsible for paying capital gains taxes on the $25,000 of appreciation that you gained from the portfolio.
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Inheritance Tax Rates & Exemptions
As previously mentioned, not all states require the payment of inheritance taxes. Only six states levy this tax in 2024: Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania.
Note: Iowa is phasing out its inheritance tax, which will be eliminated by 2025.
Most states that levy an inheritance tax allow for exemptions on part or all of the inheritance.
This means that no taxes would be due on the inheritance unless the value exceeds the exemption amount.
Once the exemption amount has been exceeded, the tax rates typically follow a sliding scale. This is similar to the way that income taxes work. The larger the inheritance, the higher the tax rate will be.
In addition to the value exemptions mentioned above, some states also consider the overall size of the estate. In Maryland, for example, any inheritance from an estate valued below $50,000 is exempt from an inheritance tax.
Finally, many states will take into consideration the relationship with the deceased. Immediate family, such as a surviving spouse, child, or parent, is often exempt from paying taxes on an inheritance received from the deceased.
| State | Exemption Rules | Tax Rate |
|---|---|---|
|
Iowa |
Immediate family (spouse, parent, child) exempt |
0-6% |
|
Kentucky |
Immediate family (spouse, parent, child, sibling) exempt |
0-16% |
|
Maryland |
Immediate family (spouse, parent, grandparent, child, grandchild, sibling) and charities exempt |
0-10% |
|
Nebraska
|
Spouse or charity exempt |
0-15% |
|
New Jersey
|
Immediate family (spouse, child, parent, grandparent, grandchild) and charities exempt |
0-16% |
|
Pennsylvania |
Spouse and minor children exempt |
0-15% |
TIP
You need to report any inheritance you receive on your tax forms for the same year the inheritance was received.
Ways To Reduce Your Inheritance Taxes
People should always be looking for ways to reduce their inheritance and estate taxes, and there are multiple ways to do this. Keep in mind that if you choose to implement some of these techniques, some gift tax may be due at the time of the transfer, but it will likely still be much less than the estate tax liability would have been.
The Bottom Line
Paying taxes on an inheritance might not seem fair, but it is a reality in several states today.
The taxes are based on the value of the individual inheritance you receive from the deceased, and you must claim this amount on your state income tax return.
Failure to do so could result in hefty penalties and fines from the Department of Revenue in your state.
Since the Federal government does not tax inheritances, you do not have to worry about claiming it on your federal return to the IRS.
If you have received an inheritance or anticipate one in the future, then make sure you are familiar with the tax laws in your state.
If you have any questions or doubts, you should always consult a tax professional to ensure you are properly claiming any inheritance you receive.
Frequently Asked Questions
It depends on the state in which the deceased lived. There is no federal taxation on inheritance.
However, some states assess an inheritance tax. In these states, the tax rates typically average around 10% and are adjusted on a sliding scale.
While you might be able to receive a small inheritance tax-free because of the exemption amount, you will pay higher taxes on more significant amounts. The higher the value of the inheritance you receive, the higher the tax rate you usually are required to pay.
Even if you live in a state that levies this tax, if the deceased person lived in a state that did not require the tax, you will likely not be subject to paying a tax on the inheritance.
Many wonder, “Is inheritance taxable even if it comes from your parents?” Again, the answer to this question depends on the deceased’s state.
Several states that levy an inheritance tax allow exemptions for immediate family members such as spouses, parents, children, and siblings. Some states limit the exemptions to spouses.
- For instance, Nebraska only allows a total exemption for spouses and charities. Children are only exempt up to $100,000.
- In Pennsylvania, adult children are only allowed an exemption up to $3,500.
- Children are entirely exempt in Kentucky, Maryland, Iowa, and New Jersey.
- If you live in Maryland, you may be subject to state estate and inheritance taxes.
If you inherit assets like cash, real estate, or even an IRA, do you have to report that inheritance to the IRS?
In most cases, you are not required to report this on your federal tax return.
There is no federal inheritance tax. This tax is only collected at the state level. If you live in a state that collects this tax, you must report the money or the value of the assets you received on your tax return.
Depending on the value of the assets and your relationship to the deceased, you might be able to exempt a portion or even all of their value.
Close family members, such as parents, children, and even siblings, are sometimes allowed certain exemptions on inheritance that prevent them from being required to pay taxes on a portion of the inheritance.
The beneficiary is responsible for paying the taxes on the inheritance. First, you need to determine whether any inheritance tax is even due.
Perhaps you live in a state that does not levy an inheritance tax, or maybe you are allowed an exemption from paying taxes on the inheritance.
If you have determined that an inheritance tax is due, the beneficiary is responsible for claiming and paying the tax.
If you file separate tax returns, you will not be required to report the inheritance on your return. However, if you file a joint return like most married couples, the inheritance must be claimed on the return and paid by either you or your spouse.
The amount of tax due on an inheritance is calculated based on the market value of the inheritance at the time of the distribution to the beneficiary.
The tax is calculated for each individual beneficiary. Here is how the tax would be calculated.
- First, determine the value of the assets that are being inherited. For cash, this is very straightforward as it is simply the amount of cash inherited. For other assets like real estate, determining the value can be slightly trickier.
- Once the value has been assessed, you should determine whether you qualify for any exemptions based on the value of the assets or your relationship to the deceased.
If you do, then subtract that amount from the total value of the inherited assets. This will give you the amount of the taxable inheritance.
From there, you should determine the tax rate at which the inheritance will be taxed by using your state’s specific tax rates. Simply multiply the taxable amount of the inheritance by the tax rate. We will walk through a simple example below.
Let’s assume that you inherit $50,000 from your brother. The state in which your brother lived allows a $10,000 exemption for siblings. So, the taxable income amount of the inheritance would be $40,000. If the tax rate for a $40,000 inheritance is 10%, then you as the taxpayer would owe $4,000 in taxes on that inheritance.
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