Taxes on Inheritance – All You Need to Know
When a parent, partner, or friend passes away, they may leave all or a share of their wealth to you. What many Americans don’t know though is that they sometimes need to pay taxes on inheritance they get from a deceased person.
Whether you pay inheritance tax depends on several factors, starting with where you live because not all states have it. Second comes the value of the inheritance since only big estates are generally taxed in the USA.
Would you like to discover if you’ll have to pay taxes on your inheritance? Do you know the difference between inheritance tax and estate tax? Scroll down and find all the answers related to this important topic.
What Is Inheritance Tax?
Americans in some states must pay tax on money/property they have inherited. Inheritance isn’t considered income and taxes that apply to it are different from estate taxes. You pay this type of tax on the assets you have inherited from a person who passed away.
How Does Inheritance Tax Work?
When a deceased person leaves an inheritance to one or more heirs, in some states, the beneficiaries pay inheritance tax. Not all states have such duties, and not all heir classes need to pay it. Also, the value of the assets plays a role in calculating the applicable tax.
Inheritance tax on property is one of the four types of taxes that affect inheritance in the United States. First, the person responsible for handling the assets deducts any applicable federal and state taxes on estates. Then, heirs are responsible for filing and paying inheritance taxes, if these are applicable in their state. Finally, if the assets are sold for a higher price in the future, capital gain taxes are paid on the price difference.
Are Inheritances Taxable?
Inheritances aren’t considered income and aren’t taxed as such. Properties worth at least $11.8 million are taxable by the federal tax. Your assets won’t be taxable if they are valued under this threshold. There is a state estate tax, capital gains, and state tax on inheritance.
So, whether your assets, properties, and money are inheritance tax exempt or taxable depends on their value and your home state. Also, some assets aren’t taxable, like anything the deceased leaves to their spouse. Money donated to charity isn’t taxable either, alongside gifts that are under the annual tax exclusion threshold. That’s one of the reasons why the US charitable giving stats show a constant growth in donations.
What States Have Inheritance Tax?
Six US states have tax on inheritance, and these are Iowa, New Jersey, Nebraska, Maryland, Pennsylvania, and Kentucky. Their exact rates vary depending on the inheritance size and state regulations. For instance, the tax in Iowa won’t go over 15%, while in Nebraska, it reaches up to 18%.
How Much Is Inheritance Tax?
Six US states apply taxes on inherited properties, assets, and money. The exact rate and amount depend on your beneficiary class and inheritance size. Below, you can find all about the thresholds, percentages, and exemptions in those six states.
- New Jersey (11% to 16%) – Immediate family members are fully exempt. There are no Class B beneficiaries in NJ as of 2019. Class C are exempt for estates under $25,000. The inheritance tax rate for Class D beneficiaries is 15% on the first $700,000 and then 16% on amounts over that threshold. Class E (charities, nonprofits, etc.) are fully exempt.
- Iowa (5% to 15%) – Assets under $25,000 are exempt from tax on inheritance.
- Maryland (10%) – Spouses, children, parents, siblings are exempt. Estates up to $1,000 are exempt from taxes on inheritance for friends, family members, etc.
- Kentucky (6% to 16%) – Class A beneficiaries are completely exempt. Class B beneficiaries get tax exemption for properties up to $1,000. Class C beneficiaries don’t pay inheritance tax on assets of up to $500.
- Pennsylvania (4.5% to 15%) – Spouses and children up to 21 years are exempt. For the rest beneficiaries, the tax rates vary.
- Nebraska (1% to 18%) – Spouses and children are exempt. Immediate relatives get tax exemption on assets up to $40,000. Remote relatives with an inheritance of up to $15,000 are exempt. All other beneficiaries pay taxes on inherited assets of at least $10,000.
Is There a Federal Inheritance Tax?
No, there is no federal tax applied to inheritances. There is only a federal tax on estates of up to 40% on assets valued over $11.8 million. Inheritance tax is regulated by state jurisdictions, and only six US states have it.
Who Pays Inheritance Tax?
The beneficiary of the inheritance pays the tax. That said, not all states impose taxes on people’s inheritance. So, unless you live in one of the six states that have it, you have nothing to worry about.
What if you live in a state that taxes inheritances and your inherited assets surpass the inheritance tax threshold? In that case, you should check the applicable taxes on the estate you inherited. Then, make sure to file and pay the due amount within the given deadline. Remember, the estate tax is deducted from the estate by the person handling the case. Inheritance taxes, by contrast, are paid from the beneficiary’s pocket.
Who Pays Estate Tax?
You must remember that inheritance and estate taxes aren’t the same. The first is paid by the person handling the deceased’s estate and is deducted from the estate. The beneficiary of the estate pays the latter. That’s the main difference between inheritance and estate tax.
The inheritance tax vs estate tax comparison doesn’t end there. Estate taxes represent the tax on proper transfer rights after a person passes away. In 2020, estates under $11.58 million were exempt from estate tax by the IRS. For properties over that amount, the tax rate can go as high as 40%. Estates and assets are taxed in compliance with their market value at the time of taxation. The price they were bought for doesn’t play a role in determining the estate tax on inherited property.
Please note that the IRS applies the federal tax on estate on deceased people’s assets and properties. Some states have their estate taxes, whose taxable threshold tends to be much lower, plus additional inheritance taxes. For instance, Massachusetts and Oregon apply state estate tax on properties valued at more than $1 million.
How Much Can You Inherit Without Paying Taxes?
If you live in one of the six states that have this type of tax, then other game rules apply. Each state has different exemption beneficiary classes and inheritance value thresholds.
You can find the exact tax rates and beneficiary classes for each state above.
How Is Inheritance Tax Calculated?
Each of the six states that tax inheritance has different regulations regarding the taxable amounts and rates. Before you deal with taxes on your inheritance, however, any federal and state estate taxes will be deducted from it first.
Why Is Inheritance Taxed?
Even though most people disagree with the idea behind the inheritance tax, there is a justified reason for its existence. Legislators believe that by promoting inherited wealth, the rich will ensure their heirs remain rich. Through these taxes, at least some share of that wealth is redistributed.
The money from taxes on inheritance then goes into the budget and is used for supporting welfare programs and community prosperity. In fact, states with this tax have higher social security benefits than the US average, according to official social security facts. Basically, the government takes part of that inheritance and ensures it benefits the community. Of course, not everyone agrees with the concept. That’s why some states don’t have such taxes, and why not all assets are taxed.
What Is Capital Gain Tax?
Capital gain taxes are closely associated with inheritance. Let’s say that you inherit assets or properties, and then you sell them for more than their value when you received them. The difference between the two values is considered a capital gain, and it’s taxable.
In addition to the federal and state estate taxes and the inheritance tax calculation, capital gain tax is the last to affect inheritances.
Remember, the capital gain is calculated for the period starting with the moment of inheriting the estate, to the moment of selling it. For example, you inherited a property worth $200,000 in 2015 and then sold it for $250,000 in 2020. The capital gain tax applies to the $50,000 difference in value. How much the deceased originally paid for the property doesn’t matter.
How Do I Avoid Capital Gains Tax on Inherited Property?
It’s not entirely possible to avoid paying the capital gains on your inherited properties. One option is to sell the assets immediately at their current value. If you sell later and for a higher price, you will have to pay the applicable capital gain tax between 0-20%.
People with a low annual income of under $40,000 are fully exempt from capital gains tax on inheritance in 2020. Most Americans pay a 15% tax on capital gains.
Is My Inheritance Taxable?
Yes and no. There is a federal tax that is first applied to the assets you are going to inherit from a deceased person. Some states have state estate taxes, as well. Additionally, six states have state inheritance tax that you will have to pay out of your pocket.
So, everything depends on where you live and on the value of your inheritance. For example, if you live in Massachusetts and inherit anything under $1 million, you won’t have to pay any taxes. If you live in Maryland and inherit assets worth over $5 million, you will have two types of taxes. First, the state estate tax will be deducted, and then you’ll have to pay an additional 10% tax on inherited money or property.
Tips for Reducing Inheritance Taxes
Sometimes, it’s impossible to avoid paying taxes on your inheritance. However, some steps can help both parties – the giving and the receiving – reduce the amount paid.
- Shield your possessions in a trust.
- Spread your assets while you’re still alive.
- Give away some of your properties to charity.
- Relocate to a state without inheritance taxes.
- Spend some of your assets if your wealth is just above the taxable thresholds.
Applying one of these or a combination should help ultimately bring down the cash inheritance tax.
Inheriting money or property in the United States often comes with strings attached. While the professionals handling the inheritance will pay any applicable estate taxes, covering inheritance taxes remains the beneficiary’s responsibility.
Failing to meet such responsibilities can result in severe consequences and hefty penalties. That’s why you must get informed on the taxes on inheritance applicable in your state. If you’re not sure how to deal with such taxes, you may want to hire a professional to handle it for you.