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Inheritance Tax: What Is It And Who Has To Pay?

Sarah Sharkey4-minute read
April 26, 2021

After losing a loved one, taking care of their wishes is a top priority. In some cases, the deceased may have left assets behind for you to inherit. The generous gesture is often a touching reminder of their love for you.

As you move forward with this inheritance process, it’s important to consider how inheritance tax will play into the picture. Depending on state laws, you may owe an inheritance tax on any property or money that you inherit. Let’s take a closer look at how this could impact you.

What Is Inheritance Tax?

An inheritance tax, in certain states, requires a beneficiary to pay a tax on inherited money or real estate. The amount of tax paid depends upon multiple factors.

Your inheritance will be subject to a tax determined by the individual state’s laws in some states. Currently, six states impose an inheritance tax – Maryland, Nebraska, Kentucky, New Jersey, Pennsylvania and Iowa.

Each state has slightly different rules surrounding their inheritance taxes. With that, it is important to seek out guidance from an expert in your home state.

How Much Is An Inheritance Tax?

Inheritance tax rates vary based on the three factors.

First, the state issuing the tax will greatly impact the amount you’ll pay with their unique tax rate. Second, the total value of the inheritance will have an obvious impact on the inheritance taxes paid. Finally, your relationship to the deceased will play a role. A more direct relationship to the deceased will often lead to a lower tax rate.

Beyond inheritance taxes, you’ll need to consider the other potentially related taxes. A couple to look out for include capital gains tax and income taxes. If you decide to sell an asset that you inherited, then capital gains taxes could come into play. Additionally, if you inherit an account such as a 401(k) or IRA, then you will likely deal will income taxes as you take distributions from those accounts.

Is There A Federal Inheritance Tax?

As you navigate the potential tax ramifications of an inheritance, there is one silver lining. You will not need to worry about federal inheritance taxes. Only a handful of states will require that beneficiaries pay an inheritance tax.

Inheritance Tax By State

As with many tax regulations, inheritance tax rates vary by state. Within each state’s tax rates for inheritance taxes, you’ll find different rules based on your relationship with the deceased. Let’s take a closer look at the tax rates that you could expect to pay in the following states:

State

Inheritance Tax Rate Range

Pennsylvania

4.5 – 15%

New Jersey

0 – 16%

Maryland

0 – 10%

Nebraska

1 – 18%

Iowa

5 – 15%

Kentucky

4 – 16%

 

Estate Tax Vs. Inheritance Tax

Although estate taxes and inheritance taxes are often discussed as interchangeable terms, they are notably different. As you navigate the waters of inheritance, it is important to understand the difference. Let’s take a closer look at both below.

Estate Tax

An estate tax is a federal tax that the deceased person’s estate owes the federal government. The federal tax is assessed and paid before the distribution of the estate’s assets.

The federal estate tax rules are only applied to wealthy estates. In order to be subject to estate taxes, the value of the estate will need to exceed an amount specified by the IRS. When the tax is assessed, the estate will only be taxed for the amount that goes over the IRS exemption limit.

In 2021, the personal estate tax exemption limit is $11.7 million. With that, most estates are not required to pay to federal estate taxes.

Inheritance Tax

In contrast to estate taxes, inheritance taxes are paid by the person who receives the inheritance. As an inheritor, you will not be subject to a federal estate tax. Instead, the state may impose an inheritance tax on your newfound assets.

Depending on where you and the deceased resided, you may not be subject to any inheritance tax.

When Do You Pay Taxes On An Inheritance?

If you and the deceased person are not residents of one of the six states with inheritance tax, then you don’t need to worry about this tax. But if you or the deceased did live in one of these six states, then you’ll need to consider your inheritance tax obligations.

When the deceased lived in a state with inheritance tax, or the inherited property is located in one of those states, the beneficiary must file an inheritance tax return to that state.

Who Is Exempt?

Of course, there are some exceptions. For example, surviving spouses are exempt from any inheritance tax. With that, if your deceased spouse left behind a home for you, there would be no need to worry about inheritance tax.

Children and other descendants of the deceased are often exempt as well. However, distant relatives and friends will have fewer exemptions in their favor.

Bottom Line

As you navigate the tax laws surrounding inheritance, don’t be afraid to ask for help. When in doubt, consult a local tax professional who can help guide you on the right path.

If you’re looking for ways to create a smoother process, then consider estate planning with a loved one today.

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    Sarah Sharkey

    Sarah Sharkey is a personal finance writer that enjoys helping readers learn more about their finances. She has an MS in Business Management from the University of Florida. You can connect with her on LinkedIn or Instagram @adventurousadulting.