What is an Inheritance Tax?
An inheritance tax is a levy that some states charge against the gift someone inherits from the estate of the deceased.
🤔 Understanding inheritance tax
An inheritance tax is a fee some states charge for the gift a person receives from the estate of a deceased person. As of 2022, six states collect inheritance tax: Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. Each state that collects inheritance taxes has its own tax rates and exemptions. There’s no federal inheritance tax in the United States because the Internal Revenue Service does not classify a gift from the decedent’s estate as income. However, some estates are subject to a separate estate tax.
Suppose Uncle Horatio dies and generously leaves money for each of his favorite relatives. He leaves $3M to his son, $2M to his niece, and $1M to his cousin. If Uncle Horatio lived in a state that collects inheritance tax, the relatives would each have to pay a percentage of the gift amount according to that state’s sliding scale. States usually set the tax rate based upon the inheritance amount and the closeness of the family connection. That means each of Horatio’s relatives will face different circumstances governing inheritance tax.
Takeaway
An inheritance tax is like the price you have to pay to receive a “free” download from the internet...
A company may be willing to give you their e-book for free, but there’s one small string attached — You have to give the company your email address. Similarly, you’re welcome to keep the inheritance you received from your late Aunt Hildegarde as long as you pay the tax authorities what they require.
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What is an inheritance tax?
Inheritance tax is the fee some states charge for inheriting a gift from a deceased person’s estate. It’s sometimes referred to as a type of “death tax.” Not everyone who inherits valuables has to pay. Only people who receive property from a decedent who lived in a state with inheritance tax laws are likely to have to pay.
As of 2022, the only six states with inheritance taxes are Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. In other words, if your benefactor didn’t live in one of those states or own property there, you probably aren’t subject to an inheritance tax.
How does inheritance tax work?
States that levy inheritance taxes take into consideration two key factors.
Value of the gift: Typically, states use the market value of the decedent’s estate at the time of death to help calculate the tax bill. However, sometimes the dollar amount of the property is based upon the market value six months after the benefactor’s death.
Relationship of the benefactor and the inheritor: Usually, family members closely related to the decedent pay less in taxes than more distant relatives. For example, spouses are traditionally exempt from inheritance taxes. Siblings may have to pay a relatively small inheritance tax compared to what cousins would have to pay.
Inheritance tax and estate tax: key differences explained
Inheritance tax and estate tax are not the same. Taxpayers tend to confuse the two, but a brief examination quickly shows the difference between them. Let’s look at three identifying characteristics.
Level of government imposing the tax: Inheritance tax is only at the state level. It’s not a tax from the federal government. In contrast, estate taxes exist at both the state and federal levels. As of 2022, the IRS only levies estate taxes on estates over $12.06M ($12.92M in 2023), or $24.12M for married couples ($25.84M in 2023). However, the IRS doesn’t consider an inheritance as income for the inheritor, so there’s no federal income tax and no need to list it on your federal tax return.
Location: The federal estate tax rate doesn’t change according to where people live. However, inheritance tax does differ based upon location. An inheritance tax might come into play if the deceased person lived in a state that collects inheritance tax or owned property there.
Who pays the tax: Estate tax is the responsibility of the estate to pay before disbursements are made to the beneficiaries. The bill for inheritance tax goes to the receiver of the gift from the estate.
Limiting your potential inheritance tax
Professional financial planners can give you steps to help reduce your likelihood of paying tax on assets given to you. One simple strategy involves gift giving. Gifts are tax-free in many states. Do your research to determine your state’s policy.
If you live in one of the many states without a gift tax and want to take advantage of the situation, talk to your benefactor. The key is for your benefactor to give you your gift while still alive rather than to bequeath it to you in a will.
As of 2022, the IRS allows you to receive up to $16,000 annually tax-free (rising to $17,000 in 2023) and up to $12.06 million (rising to $12.92 million in 2023) during the benefactor’s lifetime. And if your relative or friend stays within the IRS guidelines, they won’t have to file a return to report the gift.
The gift doesn’t have to be in the form of checks or cash. You can receive a variety of assets including homes, land, and securities.
Robinhood does not provide tax advice. For specific questions, you should consult a tax professional.
New customers need to sign up, get approved, and link their bank account. The cash value of the stock rewards may not be withdrawn for 30 days after the reward is claimed. Stock rewards not claimed within 60 days may expire. See full terms and conditions at rbnhd.co/freestock. Securities trading is offered through Robinhood Financial LLC.
