What is an Inheritance Tax
An inheritance tax is a tax imposed on those who inherit the estate of a deceased person. The inheritance tax rate depends on the value of the inheritance and the beneficiary's 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
The United States federal government does not have an inheritance tax. However, individual states may assess inheritance tax. As of 2018, only six states have inheritance taxes. These states include Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. In most of these states, assets inherited from a spouse are exempt from inheritance tax. In some cases, the children are also exempt from or face meager rates of, taxation. Beneficiaries with no familial ties will realize higher rates compared to relatives.
Inheritance Tax Thresholds
The taxation threshold varies based on the relationship between the decedent and beneficiary. For example, in Nebraska, spouses are exempt from inheritance taxes. As of 2018, a parent, grandparent, sibling, child, or another lineal descendant, including those adopted, must pay an inheritance tax of 1% on amounts over $40,000.
In contrast, remote relatives, such as aunts, uncles, nieces, nephews, and other similar descendants, by blood or adopted, must pay inheritance taxes at a rate of 13% on amounts over $15,000. All others, such as friends and distant relatives, must pay inheritance taxes at a rate of 18% on amounts exceeding $10,000. While rates and thresholds vary per state, the pattern is similar.
Inheritance Tax vs. Estate Tax
An inheritance tax is not the same as an estate tax. The imposition of an estate tax is on the net value of a deceased person's property as of the date of death. Instead, the basis of the inheritance tax is on who receives the property and the value of the property allocated to the beneficiary. According to the Internal Revenue Service (IRS), as of 2018, an estate tax is only applied to estates with values exceeding $11,180,000. If the estate passes to the spouse of the deceased person, no estate tax is assessed.
If a person inherits an estate that is large enough to trigger the federal estate tax and they live in a state with an inheritance tax, they face both taxes. The estate is taxed before it is distributed, and then inheritance is taxed at the state level.