When someone passes away, their belongings do not automatically transfer to loved ones overnight. A…
Inheritance tax is a state-level tax that beneficiaries pay when they receive assets from an estate after somebody has passed away.
The inheritance tax is different from an estate tax. However, estate planning strategies such as lifetime gifting and placing assets in a trust can help minimise both types of so-called “death taxes.”
A personalised inheritance tax strategy should consider state laws, the type of property being transferred, and the relationship between the deceased person and the beneficiary.
Key Takeaways About Inheritance Tax
- Inheritance tax is paid by the person receiving assets, not the estate itself.
- Only six states currently impose an inheritance tax.
- Spouses and close family members are often exempt from inheritance tax.
- Estate planning strategies may help reduce or avoid inheritance tax liability.
- Trusts, gifting, and life insurance may help protect assets for beneficiaries.
History and Status of the Inheritance Tax
There has not been a federal inheritance tax since 1902. According to the Tax Foundation, the United States government previously used inheritance taxes from 1862 to 1870 to help finance the Civil War and again from 1898 to 1902 to help fund the Spanish-American War.
States later began introducing inheritance taxes. New York established an inheritance tax in 1885. By 1916, 43 states had an inheritance tax.
Today, only six states impose an inheritance tax:
- Lowa
- Kentucky
- Maryland
- Nebraska
- New Jersey
- Pennsylvania
Iowa’s inheritance tax is scheduled to end on January 1, 2025.
The Tax Foundation explains that many states have eliminated inheritance taxes because they can create administrative challenges, discourage investment, and influence where individuals choose to live.
Inheritance Tax vs. Estate Tax: What Is the Difference?
Inheritance taxes and estate taxes are both considered “death taxes.” However, the person responsible for paying the tax is different.
| Tax Type | Who Pays the Tax? | How Is It Calculated? |
|---|---|---|
| Estate Tax | The deceased person’s estate | Based on the total value of the estate before assets are distributed |
| Inheritance Tax | The beneficiary receiving assets | Based on the value of the inherited assets received |
Like estate taxes, inheritance taxes usually have exemption thresholds. This means beneficiaries only owe tax if the inheritance exceeds a certain value.
In addition to federal estate taxes, several states impose their own estate taxes. Maryland is currently the only state that imposes both an estate tax and an inheritance tax.
How States Tax an Inheritance
Inheritance taxes apply based on the state where the deceased person lived or owned property. If the beneficiary lives in a state without an inheritance tax, the tax generally does not apply.
When inheritance tax does apply, the amount owed usually depends more on the relationship between the deceased person and the beneficiary than the value of the inheritance itself.
Spouses and immediate family members are commonly exempt from inheritance taxes.
Inheritance Tax Rules by State
| State | Inheritance Tax Rules |
|---|---|
| Lowa | Spouses, children, grandchildren, parents, grandparents, and other direct descendants are generally exempt. Nonexempt beneficiaries may pay rates ranging from 2% to 6%. |
| Kentucky | Spouses, parents, children, grandchildren, siblings, and certain charities are exempt. Other beneficiaries may pay rates ranging from 4% to 16%. |
| Maryland | Immediate family members, nonprofits, state-owned entities, and qualifying small estates are exempt. Other beneficiaries may pay a 10% inheritance tax. |
| Nebraska | Spouses and charities are exempt. Immediate relatives receive a $100,000 exemption and may pay a 1% tax rate. |
| New Jersey | Spouses, children, parents, grandparents, stepchildren, and charities are generally exempt. Other beneficiaries may pay rates between 11% and 16%. |
| Pennsylvania | Spouses, minor children, certain military transfers, charities, and jointly owned marital property may be exempt. Other beneficiaries may pay rates between 4.5% and 15%. |
Other Inheritance Tax Rules to Understand
Property Subject to Inheritance Tax
Inheritance tax generally applies to property, investments, and money transferred to heirs. However, each state creates its own rules about which assets are taxable.
Some states include “clawbacks” or “deathbed gifts” when calculating inheritance tax. These rules may add certain transfers made before death back into the taxable estate.
For example, Nebraska may tax property transferred below market value within three years before the person’s death. Certain assets, such as life insurance policies that are not payable to the estate, may be exempt.
Inheritance Tax Returns and Deadlines
A nonexempt beneficiary must generally file a state inheritance tax return and pay any tax owed by the required deadline.
| State | Example Filing Deadline |
|---|---|
| Lowa | 9 months |
| Nebraska | 12 months |
| Kentucky | 18 months |
Some states may allow extensions. Kentucky may also provide a discount when inheritance tax is paid early.
How Inherited Assets Are Valued
Inheritance tax is generally calculated using the fair market value of property at the date of death.
The estate administrator may work with professionals such as tax assessors and real estate agents to determine asset values.
States may charge penalties and interest for late payments. Beneficiaries who sell inherited property may also need to consider potential capital gains tax consequences.
Planning Strategies to Reduce Inheritance Tax
Because only six states currently impose inheritance taxes, most beneficiaries will not owe this tax. However, those who do may face a significant financial burden.
Inheritance tax planning can become part of an estate plan when someone lives in or owns property in a state that imposes this tax.
Common Inheritance Tax Planning Strategies Include:
- Lifetime gifting: Using annual gift tax exclusions to transfer assets before death.
- Irrevocable trusts: Placing assets into certain trusts to benefit heirs while potentially reducing taxable assets.
- Life insurance planning: Using life insurance proceeds to provide beneficiaries with funds that may not be subject to inheritance tax.
- Estate planning provisions: Including instructions in a will that allow the estate to pay inheritance taxes on behalf of beneficiaries.
The IRS annual gift tax exclusion may also help individuals transfer assets during their lifetime. However, some states have clawback rules for gifts made shortly before death.
Frequently Asked Questions About Inheritance Tax
Who pays inheritance tax?
The beneficiary who receives assets from an estate generally pays inheritance tax.
How many states have an inheritance tax?
Only six states currently impose an inheritance tax: Lowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania.
How can inheritance tax be reduced?
Estate planning strategies such as gifting, trusts, and life insurance planning may help reduce potential inheritance tax obligations.
Speak With an Estate Planning Attorney About Inheritance Tax
If you reside or own property in a state that collects inheritance tax, planning ahead can help preserve more of your wealth for your heirs.
Contact us to discuss strategies for protecting your assets and creating an estate plan designed around your goals.
