If you’re about to receive a windfall from a loved one’s estate, you might assume it’s all yours, free and clear. The reality in some states is more complicated, because certain beneficiaries must pay taxes on the assets they inherit. This particular levy is known as an inheritance tax.
Below, you’ll see who owes this tax, how rates differ among the states that still have it, and how you might reduce or avoid it if you’re planning ahead. By understanding these points, you can protect your finances if you ever find yourself inheriting real estate, bank accounts, or other valuables.
What Exactly Is an “Inheritance Tax”?
An inheritance tax is a charge that certain states impose on the value of assets you receive from someone who has died. It’s not a federal tax—only a handful of states apply it, and each has its own rules. Think of it as a fee paid by the beneficiary who inherits the assets, rather than by the estate itself.
An important distinction is that not all states require such a tax, and even within the ones that do, different groups of relatives—such as spouses, children, or siblings—may be exempt.
Inheritance Tax vs. Estate Tax
You might have seen these two terms used similarly, but they refer to separate taxes. An estate tax is imposed on the decedent’s estate before anything gets distributed to heirs. It can appear at the federal level (for very large estates) and in certain states. By contrast, an inheritance tax is a state-level levy that you, as a beneficiary, pay after you receive your portion.
So, with an estate tax, the estate itself writes the check before you get your share. With an inheritance tax, you owe a percentage based on the property or money you inherit. Understanding which tax you’re dealing with is vital for deciding what you actually net from your inheritance.
Where Inheritance Taxes Still Apply
At last count, six states continue to collect an inheritance tax: Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. If the person who died lived in any of these places, the tax might apply, regardless of your own home address.
But even in these states, there’s typically a threshold that exempts smaller inheritances, which means a lot of heirs don’t pay. It’s commonly estimated that only around two percent of beneficiaries end up owing. Ultimately, how much tax you pay comes down to how much you inherited, your relationship to the deceased, and the rules in that specific state.
The Rates You Might Face
The percentage taxed depends on the state and the amount you’re inheriting. In Pennsylvania, for example, direct descendants might owe around 4.5%. But other beneficiaries could face a rate of 12% or 15%, depending on the relationship and size of the inheritance. Meanwhile, Kentucky’s rate can go up to 16% for more distant relatives.
Iowa, one of the states with an inheritance tax, charges anywhere from 2% to 6%, but it exempts close family members. Again, your biggest takeaway should be that these details vary widely. If you need precise figures, it’s smart to check that state’s revenue department or consult a tax professional.
Exemptions and Special Rules
Several states exempt spouses and direct children from paying anything at all. In some cases, grandchildren or even siblings may be partially exempt, or they can inherit up to a certain amount tax-free. For example, Nebraska exempts a surviving spouse from any tax, but might tax siblings or nieces at varying rates once they pass a certain dollar threshold. It all hinges on local statutes.
If you’re unsure about your state’s specifics, looking up that state’s inheritance tax website or speaking with someone who knows local tax law can clarify your situation. Missing these fine-print details can cost you, especially if you assume you owe nothing.
Capital Gains on Your Inherited Assets
There’s another tax folks sometimes overlook when they turn inherited items into cash. If you sell something for more than its stepped-up value at the time of inheritance, the difference can be treated as a capital gain under federal law. For instance, maybe you inherit a family lake house worth $200,000. If you keep it for a few years and eventually sell it for $230,000, that extra $30,000 may be subject to capital gains tax. The exact rate depends on how long you held the asset and your income level.
How These Taxes Get Paid
If you owe inheritance tax, you generally submit a return and payment to the local tax authority in whichever state mandated the tax. In New Jersey, for example, the tax typically goes to the state treasury department. In Pennsylvania, you’d file a tax return with the local Register of Wills. Missing the due date can mean penalties and interest, so staying on top of timelines is crucial.
Can You Avoid It?
Once you receive an inheritance in a state that imposes the tax, you typically can’t dodge it. However, people who anticipate leaving large assets to heirs sometimes make decisions to spare loved ones from hefty bills later on. Establishing trusts, purchasing life insurance policies that pay out to certain individuals, or gifting money each year while you’re alive are common moves.
A trust, for instance, can shield assets from probate and potentially from inheritance taxes in some cases. A life insurance payout, if structured correctly, is often tax-free for the beneficiaries. Meanwhile, annual gifting means you chip away at your estate’s size before death, possibly allowing relatives to avoid crossing the threshold that triggers the tax.
What If You Need Money Now?
Imagine you’re waiting for an inheritance to resolve estate debts, pay for a funeral, or simply keep up with daily expenses. If probate hasn’t finished, you might not see that cash soon. A probate cash advance from a trustworthy funding provider can provide a portion of your expected inheritance early, though you’ll need to confirm eligibility based on estate details. You’ll repay it once the estate disburses funds to you, so it can help cover urgent financial needs without adding complex monthly loans into your life.
Final Thoughts
An inheritance can feel like a welcome gift, but in certain states, taxes might slice a chunk off the top. If the deceased lived in Iowa, Kentucky, Maryland, Nebraska, New Jersey, or Pennsylvania, it’s good to investigate whether your portion meets their taxable thresholds. Take note, too, that turning around and selling your inherited items could result in capital gains tax at the federal level.
Staying organized, understanding your state’s rules, and possibly consulting an advisor can spare you last-minute surprises. In some scenarios—particularly if you’re still waiting for the probate process to wind down—an inheritance advance can help bridge the gap. By knowing these key points, you can better protect your share and plan ahead, ensuring you maximize what’s passed down to you.
