Someone in your family has passed away, and you expect to receive a sizable portion of their assets. Don’t celebrate your unexpected windfall just yet — you may have to pay inheritance tax on those assets.
Below, learn everything you need to know about inheritance taxes, including who has to pay them, inheritance tax rates, and a few ways to avoid them.
What Is Inheritance Tax?
An inheritance tax is a state tax on the value of assets a beneficiary inherits. There is no federal inheritance tax; the tax is only levied at the state level.
Inheritance Tax vs. Estate Tax
Although you might see the terms “inheritance tax” and “estate tax” used interchangeably, they don’t mean the same thing. An estate tax is levied on the right to transfer ownership of assets when a person dies. Estate taxes may be levied at state and federal levels, while inheritance taxes are levied by states only.
Estate taxes are deducted from the value of an estate before assets are distributed to beneficiaries. Inheritance taxes, on the other hand, are due several months after a beneficiary receives their inheritance (exactly how long varies by state).
Who Has To Pay Inheritance Tax?
Currently, only six states impose an inheritance tax:
- Iowa
- Kentucky
- Maryland
- Nebraska
- New Jersey
- Pennsylvania
If you don’t live in one of these states, you may think that you can breathe a sigh of relief because inheritance taxes don’t apply. However, this might not be the case. Inheritance tax laws apply in the state where the decedent died, not where you live. So, if your family member died in Iowa and you live in Texas, you may still have to pay the tax.
Note that not everyone has to pay inheritance tax, however. An inheritance must be above a certain amount before you must pay taxes. It’s estimated that only 2% of beneficiaries will have to pay inheritance tax.
How Much Is Inheritance Tax?
How much inheritance tax you’ll owe depends on the state where the decedent passed away. Tax rates for 2024 are as follows:
- Iowa: 2%-6%
- Kentucky: 4%-16%
- Maryland: 10%
- Nebraska: 1%-18%
- New Jersey: 11%-16%
- Pennsylvania: 4.5%-15%
Inheritance Tax Exemptions
All states have exemptions that limit how much inheritance tax you’ll have to pay. You might not have to pay tax depending on your relationship with the deceased.
Spouses, for instance, are exempt from paying inheritance tax on assets their deceased husband or wife left to them (this applies in all states that levy inheritance tax). In Iowa, Kentucky, Maryland, and New Jersey, children and grandchildren do not owe any inheritance tax.
Here are a few state-specific exemptions:
Iowa
- Spouses, lineal ascendants (parents, grandparents), and lineal descendants (children, grandchildren): Exempt
- Charities: Exempt up to $500
Kentucky
- Immediate family members: Exempt
- Other recipients: Exempt up to $500 or $1,000 (based on a sliding scale)
Maryland
- Immediate family and charities: Exempt
- Other recipients: Exempt up to $1,000
Nebraska
- Spouses and charities: Exempt
- Immediate family: Exempt up to $100,000
- Other relatives: Exempt up to $40,000
- Other heirs: Exempt up to $25,000
New Jersey
- Immediate family and charities: Exempt
- Siblings and sons/daughters-in-law: Exempt up to $25,000
Pennsylvania
- Spouses and minor children: Exempt
- Parents, grandparents, and adult children: Exempt up to $3,500
Capital Gains Tax May Also Apply
In addition to inheritance taxes, you might have to pay capital gains tax if you sell one of your inherited assets. For instance, suppose that your relative left you a car worth $20,000. You decide to sell the car for $25,000. In this case, you must pay capital gains tax on the $5,000 profit earned.
Capital gains tax is levied at the federal level, so it applies to you regardless of state.
How To Pay Inheritance Tax
Exactly how you’ll pay your inheritance tax depends on the state where the decedent lived. For example, in Pennsylvania, you must send an inheritance tax return to the Register of Wills. In Nebraska, you’ll pay inheritance tax to the county of the deceased’s residence.
Regardless of state, you must pay any inheritance taxes by the due date. If you don’t, you’ll have to pay interest and penalties.
How To Avoid Inheritance Tax
If you’re holding a hefty check and wondering how to avoid paying taxes on the money, the bad news is that once you’ve received the assets, there’s no way to dodge inheritance taxes. However, there are a few ways to set things up for future beneficiaries so they don’t owe inheritance tax. If any of these strategies sound appealing, an estate planning lawyer can tell you more.
Set Up a Trust
One of the most reliable ways to avoid inheritance tax is to set up a trust. You can opt for either a revocable or irrevocable trust.
With a revocable trust, you can take assets back out of the trust if needed. On the other hand, an irrevocable trust doesn’t allow you to remove assets once you put them in. Irrevocable trusts offer more asset protection than revocable ones.
Buy a Life Insurance Policy
Consider purchasing life insurance if you don’t want to set up a trust. This tactic involves buying a policy equal to the amount you’d like to bequeath and naming a recipient as the policy’s beneficiary. When you die, the policy recipient won’t owe taxes on the death benefits.
Gift Money to Beneficiaries
A third option is to gift money to beneficiaries each year. In 2024, you can gift up to $18,000 to an individual without paying gift tax. Married couples with joint property may give away up to $36,000.
Cash Advances for Those in Probate
Are you still confused about what inheritance tax is and whether you must pay it? Need a helping hand to tide you over while you wait for your inheritance? Contact Rockpoint Probate Funding at (323) 484-1063 to learn more about our cash advances for beneficiaries going through probate and see whether they might benefit your current situation. It costs you nothing to speak with us.
