What is inheritance tax?

A tax that six states levy on someone who inherits money, property, or other assets

Derek Silva

Derek Silva

Published July 18, 2019

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KEY TAKEAWAYS

  • 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 have it

  • It’s unique from estate tax, which taxes very wealthy estates before assets are disbursed to any beneficiaries

Inheritance tax applies to the person inheriting real estate, money, investments, or other personal property. It’s calculated as a percentage of the value of everything you inherit.

Only six states collect an inheritance tax so it only affects you if the deceased person lived in either Iowa, Kentucky, Maryland, Nebraska, New Jersey, or Pennsylvania. Where you live doesn’t affect inheritance tax. Only the home of the deceased (also called the decedent) or the location of property that you’re inheriting will matter. There is no federal inheritance tax.

All states exempt a spouse from inheritance tax. Direct descendents usually pay lower tax rates, though they are also completely exempt in certain states. The less closely related you are to the deceased person, the higher your top tax rate usually is. Unrelated individuals normally pay the highest tax rates. Rates may also vary based on the age of the inheritor (minors may be exempt) or the type of asset.

The inheritance tax is applied as a percentage of the value of what you’re inheriting. Each state has its own tax brackets and rates, though the top rate is usually between 15% and 20%.

If you live in one of the states that levies an inheritance tax, it’s important for you to consider how much your inheritors will have to pay in taxes as part of your estate planning process.

In this article:

Which states have inheritance tax

There is no federal inheritance tax and only the following six states have it in 2019:

  • Iowa
  • Kentucky
  • Maryland
  • Nebraska
  • New Jersey
  • Pennsylvania

The tax only affects you if the deceased person lived in one of the states above, or if you’re inheriting property that’s in one of these states

Paying inheritance taxes

If you believe that you will owe inheritance tax, consider talking with a tax attorney or tax accountant so that you can fully understand the local tax law. Tax rates vary by state with the top rates ranging from about 15% to 20%.

To pay the tax bill, you will need to file an inheritance tax return with your state. Filing deadlines vary by state but you usually need to file a return within eight or nine months of the death.

You can often file for a six-month extension within that time too. However, if you file for an extension, you may still have to pay your tax bill (or a reasonable estimate of your bill) by the original due date. The extension may only give you more time to actually file the tax return, not to pay what you owe.

Capital gains on inheritances

It’s important to know the value of assets you inherit because you may pay capital gains tax if you sell the assets later for a profit. 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.

For example, if you inherit a house worth $250,000 and sell it years later for $350,000, then you will need to pay capital gains tax on the $100,000 profit you made. There is a federal capital gains tax and every state with an income tax also collects capital gains.

The specific rates you pay depend on how long you own the asset. Learn more about the types of capital gains tax.

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Inheritance tax vs estate tax

Inheritance and estate taxes are often confused 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. However, there are distinct differences.

Inheritance tax is paid by the person who inherits something and it’s paid based on a percentage of what they inherit. Estate tax is paid by an estate — the collection of someone’s money, real estate, and any other property — and it comes out of the estate’s value before anything is transferred to beneficiaries. Just like inheritance tax, surviving spouses are exempt from estate tax.

Estate tax applies at the federal level but only to very wealthy estates. In 2019, there is an exemption of $11.4 million, which means you don’t pay any estate tax unless your estate is worth more than $11.4 million. (The exemption will go up to $11.6 million in 2020.) Even then, you’re only taxed for the portion that exceeds the exemption. Very few estates have to pay estate tax because of the very high exemption.

Maryland is the only state in 2019 with both an inheritance and estate tax. That means an estate will pay taxes if it meets the exemption amount ($5 million in 2019) and then inheritors will have to pay inheritance tax based on how much they inherit.

How to minimize inheritance tax

As you’re estate planning, there are a few things you can do to minimize inheritance taxes for a beneficiary.

The most common strategy is to simply gift the assets during your lifetime. The federal government and many states allow you to gift thousands of dollars’ worth of assets without having to pay taxes. At the federal level, gifts can be up to $15,000 in 2019 without facing taxes. Even if it takes multiple years for you to gift everything you want, you can save on taxes.

Another option 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. Talk with an estate planning attorney to see if an irrevocable trust is a good option for you.

Because a surviving spouse is exempt from inheritance tax, married couples can consider leaving their estates to each other. This may only move the problem from you to your spouse, but it could also give them time to gift more assets, sell property, or potentially even move.

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