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Inheriting money or property can be a boon to your finances, and since just a handful of states tax inheritances, chances are good it will be a tax-free windfall, too.
That’s because the federal government generally doesn’t consider inheritances to be taxable, and only levels an estate tax on large estates of more than $11.4 million. Just 12 states and the District of Columbia have estate taxes. But what about state-level inheritance taxes?
“Only six states currently assess the tax, and it’s different depending on where you live,” says Anthony S. Park, an executor and estate attorney at Anthony S. Park PLLC in New York. “If you happen to inherit money in Iowa, Kentucky, Maryland, Nebraska, New Jersey or Pennsylvania, you should consult a tax attorney about your potential inheritance-tax liability.”
How do inheritance taxes work?
Inheritance taxes are the responsibility of beneficiaries who receive property after an individual’s death. Depending on the state, these taxes can be charged on property transferred via a will, a trust or a deed. They can also be charged on property that transfers via intestate laws of succession, which determine who inherits if the deceased hasn’t provided instructions.
“The major difference between inheritance and estate tax is who pays the tax,” Park says. “Estate taxes are paid out of the estate, off the top, before any money is distributed to heirs. Inheritance tax is paid by the beneficiary once the money has been received.”
Each state sets its own rules for how inheritance taxes work. Additionally, some counties may have their own inheritance tax. The tax is generally a percentage of the value of all the property inherited, including money, real estate and personal property. The specific percentage may depend upon the relationship of the heir to the deceased person.
The IRS generally doesn’t consider inheritances to be taxable income, so you likely won’t have to pay federal income tax on any inheritance you receive. But if you inherit property that generates income (a rental property, for example), you’ll likely have to pay tax on that income.
Who has to pay inheritance tax?
You may have to pay inheritance tax if you live in one of the six states that levies it. Here’s an overview of the rules for inheritance tax laws in each of these states. It’s important to note that rules can vary depending on the year in which a person dies.
- Doesn’t charge inheritance tax on estates of less than $25,000 (although the estate may still need to file an estate tax return).
- If a deceased person leaves their estate to a spouse, parents, grandparents, great-grandparents, children, stepchildren, grandchildren, great-grandchildren or other lineal relative, there’s no inheritance tax.
- Siblings, half-siblings, sons-in-law or daughters-in-law pay from 5% to 10%, depending on the value of the estate.
- For aunts, uncles, nieces, nephews, foster children, cousins, brothers- or sisters-in-law, and other individuals, the tax rate is from 10% to 15%, depending on the value of the estate.
- For property passed to firms, corporations or for-profit societies, the tax rate is 15%.
- Charitable, education or religious organizations pay either nothing or 10%, depending on the type of organization.
- Surviving spouses, parents, children, grandchildren, siblings and half siblings pay no inheritance tax.
- Nieces, nephews, half-nieces, half-nephews, daughters-in-law, sons-in-law, aunts, uncles or great-grandchildren pay nothing on estates of $1,000 or less, and from 4% to 16%, depending on the size, on estates of $1,000 or more.
- All other beneficiaries, including educational, religious and other organizations, pay nothing on the first $500 of an estate and from 6% to 16% on estates worth more than $500, depending on the size of the estate.
- Spouses, children, grandchildren, children’s or other lineal descendants’ spouses, parents, grandparents, stepparents, stepchildren and siblings, as well as corporations that have certain relatives as stockholders, pay no tax.
- Domestic partners who inherit their joint primary residence are exempt from inheritance tax on that residence.
- All other individuals pay 10%.
- The amount of property that’s exempt from inheritance tax depends on the relationship of the heir to the deceased person. For example, surviving spouses don’t pay inheritance tax, whereas siblings and other lineal descendants may be exempt the first $40,000 of the clear market value of inherited property. Cousins can only be exempt the first $15,000.
- Tax rates on estates above exemption amounts vary as well, depending on the heir’s relationship to the deceased. For example, siblings and lineal relatives (like children) pay 1% on amounts more than $40,000, while nonrelatives pay 18% on amounts more than $10,000.
- Spouses, children, grandchildren and other lineal descendants, parents, grandparents, stepchildren, civil-union partners, domestic partners and mutually acknowledged children don’t pay inheritance tax.
- Siblings, daughters-in-law, sons-in-law, and civil-union partners of the deceased person’s child pay no tax on the first $25,000 of inheritance. Tax rates on inheritances of more than $25,000 range from 11% to 16%.
- Qualified charities, religious institutions, educational and medical institutions, nonprofit benevolent or scientific institutions, and any New Jersey state or local government pay no tax on a bequest.
- Anyone else pays 15% on the first $700,000 of inheritance and 16% on amounts more than $700,000.
- Tax rates vary depending on the relationship of the heir to the deceased person. For example, spouses and children 21 or younger pay no inheritance tax, while adult lineal heirs pay 4.5% and siblings pay 12%.
- Certain family members are allowed to exempt $3,500 of inheritance from tax for specific purposes.
- Certain farmland and agricultural property is exempt from Pennsylvania inheritance tax if the deceased passed away after June 30, 2012.
If you don’t live in one of these states, chances are you won’t have to pay an inheritance tax — but the value of your inheritance may still be reduced if the estate of your deceased relative is required to pay federal estate tax, state estate tax or both.
Mitigating inheritance taxes
Inheritance taxes can sometimes be minimized through estate-planning techniques. For example, the federal tax code allows individuals to gift up to $15,000 per recipient without triggering federal gift taxes.
The more property you transfer during your lifetime, the less that’s transferred after death, when the property could be subject to estate and inheritance taxes.
An estate-planning attorney may be able to help families lawfully reduce taxes owed after a death.
Most Americans won’t be affected by estate or inheritance taxes.
Only Iowa, Kentucky, Maryland, Nebraska, New Jersey and Pennsylvania have an inheritance tax, and there is no federal-level inheritance tax. Just 12 states and the District of Columbia currently have state-level estate taxes, and the federal estate tax only applies to estates of more than $11.4 million.