DEFINITION of 'Inheritance Tax'
Inheritance tax is imposed on the assets inherited from a deceased person. Some states and a handful of federal governments around the world levy this tax. The tax rate on inheritances depends on the value of the property received by the heir or beneficiary and his relationship to the decedent. Inheritance tax is known in some countries as a "death duty" and is occasionally called "the last twist of the taxman's knife."
BREAKING DOWN 'Inheritance Tax'
As of 2016, only six states in the United States have inheritance taxes: Iowa, Kentucky, Maryland, Nebraska, New Jersey and Pennsylvania. In all of these states, if you inherit assets from your spouse or common-law partner, your inheritance is not taxed. In some cases, children are also exempt from inheritance taxes or face very low rates. However, heirs who are distant relatives or friends of the deceased face higher inheritance tax rates.
The taxation threshold also varies based on the relationship between the deceased and the heir. For example, in Nebraska, spouses are exempt from inheritance taxes. However, as of 2016, if a parent, grandparent, sibling, child or grandchild inherits assets, he has to pay an inheritance tax of 1% on any amount over $40,000. In contrast, slightly more distant relatives such as aunts, uncles, nieces and nephews must pay inheritance tax on any amounts over $15,000, and the rate is 13%. For friends or distant relatives who fall outside these categories, the threshold lowers to $10,000, and the tax rate increases to 18%. While the exact rates and thresholds vary, the pattern stays the same throughout the rest of the states with inheritance taxes.
Inheritance tax is not the same as estate tax, which is imposed on the total value of a person's estate when that person dies. Rather, inheritance tax is imposed on the property passed to an heir. According to the Internal Revenue Service (IRS), as of 2016, estate tax is only applied to estates worth more than $5.45 million, and if the estate is passed to the spouse of the deceased person, no estate tax is assessed. Federal estate taxes are levied on 0.2% of estates in the United States, with an average tax rate of 16.6%.
If a person inherits an estate that is large enough to trigger the federal estate tax and he lives in a state with an inheritance tax, he faces both taxes. The estate is taxed before it is distributed, and then his inheritance is also taxed at the state level.