An inheritance tax is a kind of tax imposed on beneficiaries when they inherit assets. Each inheritor is taxed separately as opposed to federal and state estate tax and income tax. However, inheritance tax is subject to the kind of relationship between the decedent and the beneficiaries. Surviving spouses and children are generally not taxed. Also, not all states impose inheritance tax.
States that impose inheritance tax
Only six US states and the District of Columbia charge an inheritance tax. The six states include:
- Iowa (up to 15%)
- Kentucky (up to 16%)
- Maryland (up to 10% of the asset transferred)
- Nebraska (up to 18%)
- New Jersey (up to 16%)
- Pennsylvania (up to 15%).
Note that each state has its own laws specifying who is exempt from the tax and how much the charged inheritors have to pay.
Out of these states, it is only Maryland that imposes both estate tax and inheritance tax.
Some states also have exemption amounts for inheritance tax. If the total estate does not surpass the exemption amount, then inheritance will not be charged in such states. For example, Maryland only charges inheritance taxes on estates above $30,000. Furthermore, the tax may be imposed on the value above that exemption amount. Say, an estate in Maryland has a value of $50,000. The tax rate will be imposed based on the $20,000 excess.
Inheritance tax is limited to the state level, not federal
The federal government does not impose inheritance taxes. However, they charge income and estate taxes, and these taxes are only paid when the estate value surpasses a certain threshold.
Inheritance tax is something that has to do with the state in which properties are being inherited. And we have established that only six states and the District of Columbia charge an inheritance tax. Aside Maryland that charges inheritance and estate taxes, inheritance tax has nothing to do with estate tax.
Even when the heirs are charged inheritance tax, the overall estate may not be taxed because it falls below the state estate tax exemption amount.
Determining whether your inheritance is subject to state tax
To know if your inheritance will be charged a tax, you have to know if the state the decedent lived in—or the state where the real property bequeathed to you is located — imposes inheritance tax. If yes, then you would have to pay up the tax before you can claim ownership. If the state in question doesn’t impose this tax, then you would be free of it.
Key-take away: Inheritance tax does not depend on where the beneficiary lives but where the decedent lived or owned property.
Differentiating inheritance tax from estate tax
Inheritance tax is very different from estate tax. While there is a threshold amount at which an estate becomes subject to estate tax, there is no threshold for inheritance tax.
If an estate values above a certain amount, the estate tax will be a percentage of the estate’s value. Your estate must be subject to federal estate tax if it surpasses $11.7 million. As for state estate tax, the threshold varies from state to state, and not all states impose estate tax.
On the other hand, inheritance tax is imposed on the value of asset each beneficiary receives.
How inheritance tax works
Let’s assume you live in New York which doesn’t impose an inheritance tax, but your grandfather lived in Maryland which charges am inheritance tax. For you to receive the assets left by your grandfather, you would have to pay an inheritance tax since you are inheriting from an inheritance tax state.
On the other hand, if you live in Maryland but your grandfather lived in New York, then you would not pay an inheritance tax. It doesn’t matter if you are coming from a tax state. So long the state you’re inheriting from is inheritance tax-free, you would be free.
If however, your uncle lived in New York, but the property he lives for you is located in Maryland, then you would also have to pay an inheritance tax because Maryland imposes the tax.