How Do Inheritance Taxes Work?

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Attorney, distinguished law professor

Benjamin Franklin once wrote in a letter to French scientist Jean-Baptiste Leroy: “[I]n this world nothing can be said to be certain, except death and taxes.” Many might say that this adage is as true today as it was in 1789. However, when it comes to inheritance taxes, only about 2 percent of people ever have to pay the tax. Most people are exempted from the tax based on:

  • The state they live in 
  • The amount of inheritance they receive
  • How closely they are related to the person who died and left them property

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For those who are subject to an inheritance tax, however, paying the tax can sting a bit. If you inherit property from someone who dies—especially if you are not related to that person—it is important to know what to expect when it comes to inheritance taxes.

What Is an Inheritance Tax?

An inheritance tax is a fee that some states charge against anyone who receives a certain amount of property from someone else when they die. The state charges a fee based on the amount of inheritance you receive. Thus, the fee is called an “inheritance tax.”

Although there is no inheritance tax at the federal level, the federal government (and some states) may also charge an “estate tax.” Although the estate tax and the inheritance tax are two separate taxes and function very differently, it is possible that the same property may be subject to both taxes, depending on the state you live in. 

What’s the Difference Between an Inheritance and Estate Tax?

The inheritance tax and the estate tax are both considered “death taxes” because both taxes are paid when someone dies and leaves property to someone else. However, the two taxes are applied very differently.

Estate taxes

An estate tax can be imposed on both the federal and state level. The estate tax is charged to the estate of the deceased person before any property is distributed to beneficiaries. The estate tax is also based on the total value of the property that is left in the deceased person’s estate at the time of their death.

That total value is then charged a percentage (between 18 percent and 40 percent), which makes up the amount the estate pays for its estate tax. At the federal level, estate taxes are charged only to estates with a total value over a certain amount. This amount varies from year to year based on the changing federal tax laws. For example, in the past three years, federal estate taxes have been charged as follows:

  • 2019: estates valued over $11.4 million
  • 2020: estates valued over $11.58 million
  • 2021: estates valued over $11.7 million

If the estate is valued under the applicable amount, the estate is “exempted” and does not have to pay a federal estate tax. Spouses are usually exempted from the federal estate tax as well. The estate only pays the tax on amounts over the exemption amount for that tax year. Likewise, if the deceased person lived in a state that charges a “state” estate tax, an additional estate tax may be incurred. There are a dozen states and one district that have an estate tax. These include:

  • Connecticut
  • District of Columbia
  • Hawaii
  • Illinois
  • Maine
  • Massachusetts
  • Maryland
  • New York
  • Oregon
  • Minnesota
  • Rhode Island
  • Vermont
  • Washington

Once the estate taxes are paid, property can then be distributed to beneficiaries. 

Inheritance taxes

Unlike estate taxes, which are paid by the estate before distributions are made, inheritance taxes are paid after distributions are made and are paid by the beneficiaries who receive property from the estate of the deceased person. The inheritance tax is based only on the total value of the property that the individual beneficiary receives. That total value is then charged a percentage (between 1 percent and 18 percent), which makes up the amount of inheritance tax that is owed.

As with the federal estate tax, states that impose an inheritance tax also may have an exemption amount such that if the total value of the property that is inherited is under the listed amount, the beneficiary does not have to pay an inheritance tax. However, the state exemption amounts are usually much lower than the federal exemption amount for the federal estate tax, so a beneficiary is much more likely to be faced with an inheritance tax than the estate is to be faced with a federal estate tax.  

What’s the Federal Inheritance Tax?

The federal inheritance tax rate is 0 percent, which is to say that there is no federal inheritance tax. This means that when someone inherits property from an estate, that beneficiary only pays an inheritance tax to the state. An inheritance tax is charged only once, when the beneficiary receives the property.

This means that the only tax that is charged at the federal level is the estate tax, and that tax is paid by the estate, before any property is distributed to the beneficiaries.

What States Have an Inheritance Tax?

There are only six states that charge an inheritance tax. These include:

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

Maryland is the only state that charges a state estate tax and an inheritance tax.

Who Typically Pays Inheritance Taxes After a Loved One Dies?

Inheritance taxes are paid by anyone who lives in one of the six states listed above that charge an inheritance tax. In addition, a beneficiary must inherit property that is valued above the state’s exemption amount. The estates of the deceased person do not have to pay inheritance taxes. Inheritance taxes are only paid by those who inherit property. 

The inheritance laws in each of the six states that have them can vary in terms of the amount that is exempted from the tax as well as the rate that is charged. In general, however, each state also exempts certain classes of persons from the state inheritance tax. If you qualify for one of these classes of persons, you might be subject to a lower tax rate on the property you inherit or you may be exempted from the inheritance tax altogether.

Who’s Exempt From Paying Inheritance Taxes?

In the six states that currently impose an inheritance tax, the tax is usually based on the value of the property you inherit and how closely you are related to the person who died. Normally, persons who are closely related to the deceased person are exempted from paying the inheritance tax. Depending on the state, these could include:

  • A spouse
  • A parent
  • Children
  • Siblings
  • Grandparents
  • Grandchildren
  • Other qualified dependents

Even if these classes of persons are not exempted from paying the inheritance tax, they may be subject to a lower rate than those beneficiaries who are not related to the deceased person. 

How Do You Calculate an Inheritance Tax?

Inheritance taxes are calculated based on the total value of the property that each individual beneficiary inherits. So if a decedent leaves $100,000 to her four neighbors, to be divided equally, assuming there is no exemption applied, then the estate would pay an estate tax on $100,000.

After the estate tax is paid, each of the four neighbors would receive their share of the $100,000 ($25,000 each) and would pay an inheritance tax only on the $25,000 that they inherited for themselves. That tax is calculated by multiplying the value of each beneficiary’s inherited property by the applicable tax rate in that state.  

How Do You Pay Inheritance Taxes?

If you live in Iowa, Kentucky, Maryland, Nebraska, New Jersey, or Pennsylvania and you inherit property from someone who died, unless you are exempted based on the nature of your relationship to the decedent, you may have to pay an inheritance tax. If so, you will be responsible for paying your tax at the time you normally pay your other taxes every year. You will have to complete an inheritance tax form for your state.

Before you do, however, you should be sure to discuss your tax status with your accountant or tax attorney to be sure that you are subject to an inheritance tax and that you are not exempted from paying the tax in your state. Not only may you be exempted because of the value of the property you receive and how closely you are related to the decedent, but there are certain types of property that you could inherit that are not subject to the inheritance tax.

These might include, for example, insurance proceeds or property inherited through a trust. Your attorney can advise you on whether you owe any inheritance tax and how much that tax may be in your state. 

Death May Be Certain, But Inheritance Taxes Are Not

Although it may seem like Benjamin Franklin was right when he said that the only things certain in life are death and taxes, he may not have been referring to the modern inheritance tax that is applicable in only six states. And even if you inherit property in one of these states, you may not have to pay any inheritance tax depending on:

  • The type of property you inherit
  • The value of the property you inherit
  • How closely you are related to the person who died

Check with your accountant or estate attorney to determine whether you have to pay inheritance taxes on any property that you inherit from a deceased loved one. 

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