Inheritance Tax

The inheritance tax is a tax imposed by certain states on heirs or beneficiaries when they receive assets upon the death of the settlor or grantor. This tax is determined by the laws of the state in which the deceased was a resident, the value of the inheritance received, and the relationship of the heir to the deceased individual.

Inheritance tax vs estate tax

Unlike the estate tax, which is imposed by the federal government, the inheritance tax is levied by the states. The six states that currently impose an inheritance tax include Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. 

Individuals who inherit property in these states must file the necessary tax forms and documentation with their state’s tax authorities to report the inheritance and calculate their inheritance tax liability. 

Another major difference between inheritance tax vs estate tax is that the inheritance tax is paid by the person inheriting the assets rather than by the estate of the deceased as in the case of the federal estate tax. 

It is also important to note that, as of 2023, there are 13 states that impose their own estate tax which is also paid by the estate of the deceased like the federal estate tax.

How do you calculate inheritance tax liability?

The primary factor in determining inheritance tax liability is the total value of the assets received by the beneficiary. These can include real estate, cash, investments, personal property, and other assets. 

In most cases, the state where the deceased person had their legal residence or domicile at the time of death will be the one to impose and collect inheritance tax. The tax laws and rates of this jurisdiction will apply in determining the tax liability that the beneficiaries will have to pay, regardless of where the beneficiaries live.

The inheritance tax is progressive so higher-value inheritances are subject to higher tax rates. Tax rates can also vary based on the relationship between the deceased person and the beneficiary. In some cases, close family members may have lower tax rates or be exempt from the tax. Generally, spouses are allowed to inherit assets from their deceased spouse without being subject to inheritance tax.

Most states provide exemptions and deductions that can reduce the taxable value of the inheritance. Common exemptions may include a threshold amount below which no tax is owed, exemptions for certain types of property (e.g., a family home), and deductions for funeral expenses, outstanding debts, and administrative costs. Upon completing an inheritance calculation to determine the amount of assets inherited by the beneficiary, the inheritance tax liability will only apply above the exemption amount.

Do beneficiaries have to pay taxes upon receiving an inheritance?

Unlike the estate tax which is paid by the deceased person’s estate, inheritance tax is paid by the beneficiaries. Thus, in determining who pays for succession as assets transfer from one person to another, we may be looking to a number of individuals who are beneficiaries of the estate, rather than just the estate itself.

Only beneficiaries who inherit property held by someone who was domiciled in the states mentioned above at the time of death (Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania) might be liable for paying inheritance taxes. Beneficiaries may be eligible for certain exemptions or credits, depending on the jurisdiction, which could help reduce the overall tax liability. 

How much money can you inherit without paying taxes?

From an inheritance tax perspective, the amount of money that one can inherit without paying taxes varies based on the state and the familial relationship to the deceased.

It is also possible for an heir to be subject to both the inheritance tax and the estate tax if the value of the assets exceeds both the federal estate and gift tax exemption and the state inheritance tax exemption in their respective state.

While estate taxes are not paid by the beneficiaries but rather by the estate of the deceased, the assets technically come out of the beneficiaries’ inheritance. In that case, it’s helpful to know that the current federal laws provide a $12.92 million estate tax exemption per individual in 2023. This is the amount that an individual’s estate can pass on without being subject to federal estate taxes.

There are several estate planning strategies that could help individuals reduce the inheritance tax, including the use of trusts that remove assets from the deceased’s estate. Our estate planning checklist can guide you in ensuring that your estate planning documents cover everything needed to pass on wealth in the most efficient manner.

An estate planning software like Vanilla can help advisors and their clients plan ahead by seeing how much of their estate may be subject to inheritance taxes based on their state of residence.