Inheritance tax is a state-level tax that people may have to pay when they receive an inheritance from someone who was a resident of one of the six states that levy an inheritance tax. The tax generally applies whether you receive money, investments, real estate, or anything else of value. It also typically applies whether you received the assets via a will, transfer-on-death deed, trust, or when you become an heir due to intestacy law.
There is no federal inheritance tax and only six states collect an inheritance tax in 2021 and 2022, so it only affects you if the decedent (deceased person) lived or owned property in Iowa, Kentucky, Maryland, Nebraska, New Jersey, or Pennsylvania. Where you live doesn't affect inheritance tax. Only the home of the deceased or the location of property that you're inheriting will matter.
Your tax liability is determined as a percentage of the value of what you inherit, but how much inheritance tax you pay depends on your state. States set their own inheritance tax rate and there are usually multiple categories for beneficiaries, each with their own tax brackets, based on how closely related they were to the decedent. All states exempt surviving spouses from inheritance tax. Otherwise, closely related individuals usually pay the lowest tax rates with unrelated people paying the highest rates.
Inheritance tax applies to the person inheriting assets, based on the value of their inheritance.
Surviving spouses are exempt and the tax rates are higher the less closely related you are to the deceased.
There’s no federal inheritance tax and only six states impose one.
It’s unique from estate tax, which taxes very wealthy estates before assets are disbursed to any beneficiaries.
How much is inheritance tax?
There is no federal inheritance tax and only six states have a state-level inheritance tax: Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania.
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State inheritance tax rates in 2021 & 2022
|State||Inheritance tax rate|
|Iowa||4% to 12%|
|Kentucky||4% to 16%|
|Nebraska||1% to 18%|
|New Jersey||11% to 16%|
|Pennsylvania||4.5% to 15%|
If you live in a state with inheritance tax, it’s important to consider how much your inheritors will have to pay.
Who has to pay inheritance tax
In general, inheritance tax affects you if you receive an inheritance from someone who lived in a state with inheritance tax, or if you're the beneficiary of property that's in one of these states. A taxable inheritance can include money, real estate, personal property that generates income, and the proceeds of a life insurance policy. Surviving spouses are exempt from inheritance taxes in all states. The children and parents of a decedent are often exempt too, but not in all states. You may also be exempt from taxation if your inheritance was worth less than $500.
The inheritance tax rate vary based on a beneficiary's relationship to the decedent and based on the fair market value of the assets inherited. States set a deadline for you to pay the tax, and you also have to file an inheritance tax return.
Capital gains tax on an inheritance
You may pay capital gains tax on assets you inherit if you sell the assets later for a profit, so it’s important to know their value. Capital gains tax applies whenever you sell an asset for a higher price than what you got it for. The tax applies to investments, property, and other valuables, like an art collection. There is a federal capital gains tax and every state with an income tax also collects capital gains.
In most cases, assets you inherit will have a stepped-up basis, meaning your capital gains tax would be calculated using the value of the asset when you received it instead of the value of the asset when it was first purchased. So if your parents bought a house for $100,000 decades ago and you inherit the house when it’s worth $300,000, then any capital gains from you selling the house are calculated as your sale price minus $300,000 (not the original $100,000). Not all assets will receive a stepped-up basis, though, so it’s important to understand the value of your assets for tax purposes.
Inheritance tax vs estate tax
People confuse inheritance and estate taxes because they both apply to assets passed on after someone’s death. You may also hear each of these referred to as a death tax.
Inheritance tax is paid by the person who inherits something and it’s paid based on a percentage of the value of their inheritance. Estate tax is paid by an estate — the collection of everything someone owned when they died — and the tax comes out of the estate’s value before anything is passed on to beneficiaries. Surviving spouses are also exempt from estate tax.
Estate tax applies at the federal level but very few people actually have to pay it. In 2022, there is an estate tax exemption of $12.06 million, meaning you don’t pay estate tax unless your estate is worth more than $12.06 million. (The exemption was $11.7 million for 2021.) Even then, you’re only taxed for the portion that exceeds the exemption. There are also 12 states (plus the District of Columbia) that collect their own estate tax. Maryland is the only state with a state-level estate tax and an inheritance tax.
Estate and inheritance taxes also have separate tax returns.
How to avoid paying inheritance tax
If you live in a state with an inheritance tax, there are a few main ways to minimize or avoid inheritance taxes for a beneficiary:
Leave your whole estate to your spouse (or other exempt individuals).
Give assets away before you die.
Pass on inheritances via an irrevocable trust.
Move to a different state before you die.
The simplest way to help your heirs avoid inheritance tax is to leave your estate to individuals who are exempt. Surviving spouses are always exempt from inheritance tax, but you may need to leave them your entire estate for them to receive the exemption. If you live in a state where other individuals are exempt, naming them your beneficiaries should also work.
Minimize inheritance tax through gifts
The most common strategy for avoiding inheritance tax is to gift the assets during your lifetime. The federal government and many states allow you to give away thousands of dollars’ worth of assets without having to pay taxes.
At the federal level, you can make annual gifts worth up to $16,000 (per person) in 2022 without paying any gift taxes. Even if you give assets worth more than the annual limit, you don’t actually have to pay gift tax unless you have exceeded your lifetime exemption, which is the same as the estate tax exemption.
Minimize inheritance tax through a trust
Another way to potentially avoid inheritance tax is to set up an irrevocable trust. A trust is a separate legal entity from the person who creates it and it allows you to move assets from your possession into the trust. (This also decreases the value of your taxable estate.)
However, an irrevocable trust can only help with inheritance tax if the person who creates it no longer has control over it. They cannot have the right to change beneficiaries or receive any income from the trust. For that reason a revocable trust won't help your beneficiaries avoid inheritance tax.
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