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What Are Inheritance Taxes?

Updated for Tax Year 2022 • December 1, 2022 09:02 AM


OVERVIEW

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.


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Introduction

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 2022, 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.

Comparison with estate tax

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 inheritance tax works

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.

States with an inheritance tax

The federal government does not have an inheritance tax. The six states that impose an inheritance tax are:

  1. Iowa
  2. Kentucky
  3. Maryland
  4. Nebraska
  5. New Jersey
  6. Pennsylvania

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.

Inheritance tax exemptions

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.

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