What Is Inheritance Tax?
An inheritance tax is a tax imposed by some states on the recipients of inherited assets. In contrast to an estate tax, an inheritance tax is paid by the recipient of a bequest rather than the estate of the deceased.
The inheritance tax is not common in the U.S. In fact, just six states have an inheritance tax as of 2023, and the taxation depends on the state in which the deceased lived or owned property, the value of the inheritance, and the beneficiary's relationship to thedecedent. Taxes for 2022 are paid in 2023.
Key Takeaways
- Inheritance tax is a levy on assets inherited from a deceased person.
- Unlike the estate tax, which is levied on the value of an estate and is paid by it, an inheritance tax is levied on the value of the inheritance received by the beneficiary, and it is the beneficiary who pays it.
- There is no federal inheritance tax, but inherited assets may be taxed for residents of Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania.
- Whether you will pay inheritance tax depends on the amount of the inheritance and your relationship to the deceased—with lower amounts inherited from close relatives more likely to be exempted.
- Inheritance taxes can be minimized or avoided by leaving heirs money via trusts or insurance policies, or by gifting sums during one's lifetime.
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 may be imposed on the bequest's beneficiaries.
There is no federal inheritance tax in the U.S. While the U.S. government taxes large estates directly—imposing estate taxes and, if relevant, income tax on any earnings from the estate—it does not impose an inheritance tax on those who receive assets from an estate.
Inheritance taxes are collected by six U.S. states: Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. Whether yourinheritancewill 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 may be assessed by the state or states where the decedent lived or owned property.
How Inheritance Taxes Are Calculated
An inheritance tax, if due, is applied only to the portion of an inheritance 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 with your relationship to the deceased—more so than with the value of assets you are inheriting.
As a rule, the closer your familial relationship to the deceased, 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 are only subject to an inheritance tax 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 estate or a revocable trust was the beneficiary of the policy.
Inheritance Tax Thresholds
In most states, an inheritance tax applies to bequests above a certain amount. In a few instances, the size of the estate is significant. For example:
- In Iowa, if the estate is valued at less than $25,000 then no tax is due when property passes to the recipients.
- In Maryland, inheritances from estates smaller than $50,000 are also exempt.
There are further exemptions for heirs, depending on how closely related they were to the deceased. Here are the details by state:
- Iowa:Spouses, lineal ascendants (parents, grandparents, and great-grandparents), and lineal descendants (children, stepchildren, grandchildren, and great-grandchildren) are exempt; charities exempt up to $500. The tax rate on others ranges from 3% to 9% of inheritance in 2022.
- Kentucky:Immediate family members (spouses, parents, children, siblings) are exempt; other recipients exempt up to $500 or $1,000. The tax is on a sliding scale based on the size of inheritance and includes a minimum amount, plus a percentage ranging from 4% to 16%.
- Maryland:Immediate family (parents, grandparents, spouses, children, grandchildren, siblings) and charities exempt; other recipients exempt up to $1,000. The tax rate is 10%.
- Nebraska: Spouses and charities fully exempt; immediate family (parents, grandparents, siblings, children, grandchildren) exempt up to $40,000 (rising to $100,000 in 2023). Other relatives are exempt up to $15,000 ($40,000 in 2023) and unrelated heirs up to $10,000 ($25,000 in 2023). Prior to 2023, the tax rates above those exemptions are 1%, 13%, and 18%, respectively. Starting in 2023, those rates rise to 1%, 11%, and 15%, respectively.
- New Jersey:Immediate family (spouse, children, parents, grandparents, grandchildren) and charitable organizations exempt. Siblings and sons/daughters-in-law exempt up to $25,000. The tax rate ranges from 11% to 16%, depending on the size of inheritance and the familial relationship.
- Pennsylvania:Spouse and minor children exempt. Adult children, grandparents, and parents are exempt up to $3,500. The tax rate is 4.5%, 12%, or 15%, depending on the relationship.
Consider giving money gradually, while you're alive, to recipients—instead of a lump-sum bequest upon your death. With the exception of Connecticut, states usually don't tax gifts.
Inheritance Tax vs. Estate Tax
Inheritance taxes and estate taxes are often lumped together. 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 the decedent's estate, and the estate pays it. In contrast, an inheritance tax is levied on the value of an inheritance received by the beneficiary, and it is the beneficiary who pays it.
The distinction between an estate tax and an inheritance tax with identical rates and exemptions might make no difference to a sole heir. But in some rare situations, an inheritance could be subject to both estate and inheritance taxes.
According to the Internal Revenue Service (IRS), federal estate tax returns are only required for estates with values exceeding $12.06 million in 2022 (rising to $12.92 million in 2023). If the estate passes to the spouse of the deceased person, no estate tax is assessed. Taxes for 2022 are paid in 2023.
If a person inherits an estate large enough to trigger the federal estate tax, the decedent lived or owned property in a state with an inheritance tax, and the bequest is not fully exempt under that state's law, the beneficiary facesthe federal estate tax as well as a state inheritance tax. The estate is taxed before it is distributed, and the inheritance is then taxed at the state level.
Heirs may also face a state estate tax. As of 2023, 12 states and one district still collected estate taxes: Connecticut, District of Columbia, Hawaii, Illinois, Maine, Massachusetts, Maryland, New York, Oregon, Minnesota, RhodeIsland, Vermont, and Washington.
If you live in a state with 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 state estate tax exemptions may be as low as $1 million.
Maryland is currently the only state that imposes both an estate tax and an inheritance tax.
Avoiding Inheritance Tax
While there are a lot of exceptions and exemptions for inheritance taxes, especially for spouses and children, residents with significant assets in a state with one may still want to minimize the exposure for heirs.
One common strategy is to buy a life insurance policy in the sum you wish to bequeath and make the person you want to leave it to the beneficiary of the policy. The death benefit from an insurance policy is not subject to inheritance taxes.
You could also put assets in a trust—preferably an irrevocable trust. This effectively removes them from your estate and their classification as an inheritance upon your death. You can set up a schedule for the distribution of the funds when you establish the trust.
Trusts are complicated animals and must be set up and worded carefully and meticulously to comply with state tax laws. So don't try doing so without the help of a trust and estates attorney.
How Much Can You Inherit Without Paying Taxes?
The six U.S. states with inheritance taxes provide varying exemptions based on the size of the inheritance and the familial relationship of the heir to the deceased. The federal estate tax exemption shields $12.06 million from tax as of 2022 (rising to $12.92 million in 2023). There's no income tax on inheritances.
What Is the Federal Inheritance Tax Rate?
There is no federal inheritance tax—that is, a tax on the sum of assets an individual receives from a deceased person. However, a federal estate tax applies to estates larger than $12.06 million for 2022 (rising to $12.92 million in 2023). The tax is assessed only on the portion of an estate that exceedsthose amounts. The rate is on a sliding scale, from 18% to 40%.
Do Beneficiaries Have to Pay Taxes on Inheritance?
It depends on their familial relationship to the deceased and on the state where the decedent lived or owned property. Only estates or property located in one of six states that impose inheritance taxes may be subject to them.
Surviving spouses are always exempt from inheritance taxes. Other immediate relatives, like the deceased's parents, children, and siblings, are exempt to varying degrees, depending on the state. They may be entitled to inherit a certain sum tax-free and to pay a lower tax rate on the remainder.
Inheritance taxes mainly affect more distant relatives and unrelated heirs.
How Is Inheritance Tax Calculated?
Inheritance tax rules vary by state. Most states divide beneficiaries into different classes, depending on their family relationship to the deceased (immediate, lineal, unrelated), and set exemptions and tax rates based on those categories.
Most states only apply tax to an inheritance above a certain amount. They then charge a percentage of this sum; it may be flat or it may be graduated. Kentucky, for example, imposes a rate that ranges from 4% to 16%, rising as the inheritance amount does, from $1,000 to over $200,000. It also imposes a flat dollar figure, ranging from $30 to $28,670, based on the sum inherited.
The Bottom Line
Inheritance taxes only affect residents in six states. And they mainly apply to distant relatives or those completely unrelated to the deceased. Spouses are always exempted, and immediate family members—children, parents—often are as well. Siblings, grandchildren, and grandparents, if they're taxed at all, receive more generous terms (larger exemptions, lower rates).
Still, inheritance taxes can kick in at relatively small inheritance amounts—sometimes as little as $500. Those considering bequests that could be subject to an inheritance tax might consider estate-planning strategies including gifts, insurance policies and irrevocable trusts.
