An Introduction to Inheritance Taxes

An inheritance tax is a tax imposed on heirs when they inherit assets from a deceased person's estate. Unlike an estate tax, which is based on the total value of the estate, an inheritance tax is based on the relationship between the beneficiary and the deceased, as well as the value of the specific inherited property. It also depends on where the deceased lived.

While some states have both inheritance and estate taxes, others do not have any death taxes at all. Only six states in the U.S. currently charge an inheritance tax, and even if you live in one of these states, you may not necessarily have to pay it.

State Inheritance Taxes

States that collect an inheritance tax include Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. Each state has its own rules regarding who is exempt from the tax, who is required to pay it, and how much is owed. For example, Iowa is in the process of phasing out its inheritance tax entirely by 2025.

Exemption amounts are typically set by each state and estates falling below these thresholds are not subject to the tax. For instance, in Nebraska, beneficiaries under the age of 22 are exempt from inheritance tax.

State Inheritance Tax Rates and Exemptions

Each state that imposes an inheritance tax has its own rates and exemptions. For example, Iowa's tax rate ranges from 3% to 9%, with an exemption of $25,000. Kentucky's tax rate varies from 4% to 16% with exemptions of $500 or $1,000.

Federal Inheritance Tax

Unlike state inheritance taxes, the federal government does not have a specific inheritance tax. Instead, it has an estate tax that applies to your gross estate value exceeding the lifetime exclusion amount, which is $12.06 million for 2022.

Inheritances themselves are generally not considered taxable income, but certain assets like retirement accounts may generate taxable income upon withdrawal.

How Inheritance Taxes Work

Inheritance taxes are levied by the state where the deceased lived or owned property. For example, if you live in a state without an inheritance tax but inherit from someone who lived in a taxing state, you may be subject to that state's tax.

The amount of tax owed depends on your relationship to the deceased and the value of the inheritance. Typically, the executor of the estate will calculate and subtract the tax due from your bequest before distributing it to you.

Conclusion

An inheritance tax is a state-level tax imposed on heirs receiving assets from a deceased person's estate. While some states have inheritance taxes, others do not. Understanding the rules and exemptions in your state can help you navigate the complexities of inheritance taxes.