What Is Inheritance Tax?
An inheritance tax is a tax imposed by certain states on those who are bequeathed or recieve assets from the estate of a deceased person. The tax rate depends on the state of residence, 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."
- Inheritance tax is a levy on assets inherited from the estate of a deceased person.
- There's is no federal inheritance tax, but inherited assets may be taxed by the state in Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania.
- Whether you will pay inheritance tax depends on the value of the assets and your relationship to the deceased—with lower values and closer relatives being less likely to be subject to tax.
Understanding Inheritance Taxes
An inheritance tax is not the same as an estate tax. An estate tax is assessed on the estate itself before its assets are distributed, while an inheritance tax is imposed on a beneficiary when they receive assets.
In the U.S., there is no federal inheritance tax. While the U.S. government taxes large estates directly—imposing estate taxes and if relevant, income tax on any earnings from the deceased estate—it does not impose an inheritance tax on those who receive assets from an estate.
In the U.S., inheritance taxes are strictly a state levy. Six states (Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania) impose inheritance taxes. Whether your inheritance will be taxed, and at what rate, depends on its value, your relationship to the person who passed away, and the prevailing rules where you live.
Inheritance tax is assessed by the state where the heir or beneficiary resides.
How Inheritance Taxes Are Calculated
An inheritance tax, if due, is applied only to the sum that exceeds an exemption amount. Above those thresholds, tax is usually assessed on a sliding basis. Rates typically begin in the single digits and rise to between 15% and 18%. Both the exemption you receive and the rate you're charged may vary by your relationship to the deceased—more so than with the value of assets you are inheriting.
As a rule, the closer your relationship to the decedent, the higher the exemption and the lower the rate you'll pay. Surviving spouses are exempt from inheritance tax in all six states. Domestic partners, too, are exempt in New Jersey. Descendants pay no inheritance tax except in Nebraska and Pennsylvania.
Life insurance payable to a named beneficiary is not typically subject to an inheritance tax. It may be subject to an estate tax, if the deceased person or their estate was the beneficiary of the policy.
Inheritance Tax Thresholds
In most states, an inheritance tax applies to bequests above a certain amount, In Iowa, if the estate is valued at less than $25,000 then no tax is due when property passes to the recipients. Likewise, in Maryland, inheritances from estates smaller than $50,000 are also exempt.
There are further exemptions for recipients of an inheritance, depending on how close the person was to the deceased. Here are the threshold minimums at which inheritance tax may be imposed on some recipients.
- Iowa: Immediate family exempt; charities exempt up to $500; no exemption for other recipients
- Kentucky: Immediate family exempt; other recipients exempt up to $500-$1,000
- Maryland: Immediate family and charities exempt; other recipients exempt up to $1,000
- Nebraska: Spouse and charities exempt; other family and recipients exempt up to $10,000-$40,000
- New Jersey: Immediate family and charitable organizations exempt; other family exempt up to $25,000; no exemption for other recipients
- Pennsylvania: Spouse and charities exempt; certain family members exempt up to $3,500; no exemption for other recipients
Inheritance Tax vs. Estate Tax
Inheritance taxes and estate taxes are often lumped together as "death taxes." However, they are two distinct forms of taxation.
Both levies are based on the fair market value of a deceased person's property, usually as of the date of death. But an estate tax is levied on the value of—and comes out of—the decedent's estate. In contrast, an inheritance tax is levied on the value of the inheritance received by the beneficiary, and it is the beneficiary who pays it.
Of course, if you were the sole beneficiary of an estate, that might seem like the same thing—the amount the estate is worth, and the amount you inherit. But technically, they are subject to different taxes. And in some situations, an inheritance could be subject to both estate and inheritance taxes.
According to the Internal Revenue Service (IRS), the federal estate tax is only applied to estates with values exceeding $11.4 million in 2019 and 11.58 million in 2020. 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 the inheritance is then taxed at the state level.
They may also face a state estate tax. As of 2019, a dozen states and one district still have these levies: Connecticut, District of Columbia, Hawaii, Illinois, Maine, Massachusetts, Maryland, New York, Oregon, Minnesota, Rhode Island, Vermont, and Washington State.
Maryland is currently the only state that imposes an estate tax and an inheritance tax.
If you live in a state that has an estate tax, you're more likely to feel its pinch than you are to pay federal estate tax. The exemptions for state and district estate taxes are all less than half those of the federal assessment. Some go as low, relatively speaking, as $1,000,000.