Inheritance taxes are taxes that a person needs to pay on money or property they have inherited after the death of a loved one. Here are the basics.
• An inheritance tax is levied on the assets from a deceased person's estate that are received by an individual. The person who receives the assets is responsible for paying the tax.
• The federal government doesn't have an inheritance tax. As of 2023, six states impose an inheritance tax: Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania.
• Generally, the value of the inherited assets has to exceed at least $1 million before an inheritance tax is due. As a result, only about 2% of taxpayers ever encounter this tax.
What are inheritance taxes?
An inheritance tax is a state tax that you pay when you receive money or property from the estate of a deceased person. Unlike the federal estate tax, the beneficiary of the property is responsible for paying the tax, not the estate. As of 2023, only six states impose an inheritance tax. And even if you live in one of those states, many beneficiaries are exempt from paying it.
Additionally, Iowa passed legislation to phase out its inheritance tax until it is eliminated for deaths on or after January 1, 2025.
How are inheritance taxes different from estate taxes?
The key difference between estate and inheritance taxes lies in who is responsible for paying it.
- An estate tax is levied on the total value of a deceased person's money and property, less an exclusion amount, and is typically paid out of the decedent’s assets before distribution to beneficiaries.
- An inheritance tax is levied on the person that receives assets from an estate and is typically based on the amount that is received.
However, before an inheritance tax is due, the value of the assets have to exceed certain thresholds that change each year, but generally it’s at least $1 million. Because of this threshold, only about 2% of taxpayers will ever encounter this tax.
How is inheritance taxed?
If a loved one passed away and left you money or assets in their will, you may be wondering: is inheritance taxable? Whether your inheritance is taxed often depends on your state or the state of the deceased individual.
The amount that you owe on an inheritance also varies depending on a wide range of factors, such as the:
- Size of the estate
- Tax laws in your state
- Your relationship with the deceased individual
The rate at which your inheritance is taxed is only applied to the portion of your inheritance that exceeds your jurisdiction’s exemption threshold. Any inheritance above those thresholds will be subject to inheritance taxes on a sliding scale, with rates increasing the more you inherit.
TurboTax Tip: In most states, spouses are exempt from the tax when they inherit property from another spouse. Children and other dependents may also be exempt from the inheritance tax, though in some cases, only a portion of the inherited property may qualify.
How do inheritance taxes work?
Once the executor of the estate has divided up the assets and distributed them to the beneficiaries, the inheritance tax comes into play. The amount of tax is calculated separately for each individual beneficiary, and the beneficiary has to pay the tax.
- For example, a state may charge a 5% tax on all inheritances larger than $2 million.
- Therefore, if your friend leaves you $5 million in their will, you only pay tax on $3 million, which is $150,000.
- The state would require you to report this information on an inheritance tax form.
What states have an inheritance tax?
The federal government does not have an inheritance tax. The six states that impose an inheritance tax are:
- New Jersey
Of course, state laws are subject to change, so if you are receiving an inheritance, check with your state's tax agency. The tax rates on inheritances range from less than 1% to as high as 20% of the value of property and cash you inherit.
How is inheritance tax calculated?
Because inheritance tax rules vary by state, the rate at which they’re taxed can also vary.
Many states calculate inheritance taxes based on the closeness of the relationship between the beneficiary and the deceased individual. Often, the closer you are to the person who passed away, the higher the likelihood you will be exempt from paying inheritance taxes.
When it comes to calculating inheritance taxes, the tax is often applied to inheritance above a certain amount, with the rate either being flat or graduated on a sliding scale.
Is cash inheritance taxable income?
Cash received as an inheritance isn’t taxable, according to the IRS.
But, if the cash you received later generates further income–for example, if you have it in an interest-bearing account–subsequent earnings may be considered taxable income. Whether it’s taxable hinges on whether those subsequent earnings come from a tax-free source.
If you’re unsure whether the cash inheritance you’ve received is considered as generating further income, a tax professional can help you determine whether it’s exempt.
How can you avoid taxes on inheritance?
In some cases, you may be able to avoid getting taxed on your inheritance. The most common solution for how to avoid inheritance tax is by giving inheritance to those closest in relation to you.
Depending on your relationship to the decedent, you may receive an exemption or reduction in the amount of inheritance tax you must pay.
- Most states exempt a spouse from the tax when they inherit the property from another spouse.
- Children and other dependents may qualify for the same exemption, though in some cases, only a portion of the inherited property may qualify.
- Generally, the higher rates of tax will be paid by those who inherit property from a decedent with whom they have no familial relationship.
Aside from the relationship between the deceased individual and the beneficiary, there may be other way taxes on your inheritance can be avoided, including:
- If you live in a state that imposes inheritance taxes, you can consider moving to a state that doesn’t impose inheritance taxes before the inheritance is given.
- A loved one can place their assets in an irrevocable trust fund for you (and other beneficiaries) that doesn’t have an official property transfer when they pass, allowing you to avoid inheritance taxes.
Get more tips for how to protect your inheritance from taxes.
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