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What is Inheritance Tax?

Posted on by Dawna M. Roberts in LawApril 12, 2023

The death of a family member is difficult. Apart from grief, a person may feel suffocated by impending obligations. While some obligations are easily completed (“Yes, Aunt Deborah, you can have the set of pans”), other commissions require assistance. Six states apply inheritance taxes to a deceased person’s beneficiaries; how it works, who must pay it, and how to avoid it are listed below.

What is Inheritance Tax?

An inheritance tax is one type of death tax; it exerts power over the beneficiary of inheritance and requires the benefactor to pay it. Death taxes also include estate taxes--colloquially conflated with inheritance and others. Part of the reason for conflation comes from unfamiliarity. Inheritance taxes only impact the residents ofsix states and tend only to impactdistant relativesand unrelated beneficiaries. Due to limitations, only some taxpayers will pay or see an inheritance tax.

Why do you pay taxes on inheritance?Like other taxes, an inheritance tax is one way for a localized government to gain revenue. Beyond that, the beneficiaries of an inheritance must pay the tax because it has a different value from the estate. The differences outlining inheritance taxes and estate taxes are expounded below.

How Inheritance Tax Works

Inheritance taxes combine traditional taxes (like income) and exemptions. The six states that require an inheritance tax may do so only when specific requirements are met; subsequently, only some of those who receive property from these states will see the tax. One such requirement, for example, is exemption amounts—specialized by location. These exemption amounts are vital to the inheritance tax because they mark when a beneficiary can expect it.

Further, they indicate what part of the inheritance will be taxed and forhow much. States involved with these taxes can only tax a beneficiary’s inheritance if the inheritance surpasses those exemption amounts—or if the beneficiary themselves do not qualify for an exemption through familial relations (below). Generally, those who are inheriting lower amounts of value and who were close with the deceased will find an exemption.

inheritance tax

How Much is Inheritance Tax?

Inheritance tax does not have a fixed rate across all six states, although there are predictable elements some states share. For example, beneficiaries who are long-term spouses will usually never face inheritance tax; in contrast, differing exemption amounts across state lines make things confusing. Those who live in or had a family member within an inheritance taxing state will see varying rates based upon:

  • State legislature:inheritance taxes are approved by local states—there are no federal-level inheritance taxes, though there may be other federal-level death taxes.
  • The value of the inheritance:if the overall inheritance is under the exemption limit, the benefactor doesn’t qualify for an inheritance tax.
  • The relationship between the deceased and the heir:the states recognize some relations as being “obvious”; spouses and children are usually safe from taxation.
  • Tax rates:check with your local laws to get local information about rates in your area--Iowa is ending its inheritance taxation come 2025.

When is inheritance taxable?Inheritances are taxable when they surpass the state’s exemption limit. The amount of taxation changes depending on the elements above and the state laws where the property or inheritance physically resides.

How Inheritance Taxes Are Calculated

Inheritance taxes are calculated on a sliding scale, specialized for each state. When there is inheritance taxable, rates can range between 3-18% of the non-exempt inheritance. In Maryland, for example, immediate family and charities are completely exempt from taxation. However, if a non-family heir benefited from the inheritance, they are only exempt up to $1,000. Additionally, Maryland’s base inheritance rate is 10%; this means the inherited amount beyond that $1,000 threshold is taxed at 10%.

Who Pays Inheritance Tax?

The people who pay inheritance tax are beneficiaries of inheritances from one of the following states: Iowa, Kentucky, Maryland, Nebraska, New Jersey,orPennsylvania. Generally, immediate family and spouses don’t need to worry about taxation, nor do ascendants or descendants from the deceased. Charities typically gain a special exemption range, depending on the amount they are given and the state. For example, charities are completely exempt in Maryland, but in Iowa, charities are only exempt up to $500.

Inheritance Tax vs. Estate Tax

Inheritance taxes and estate taxes are two separate avenues for government taxation. They are frequently placed under the umbrella term of “estate taxes” or, as written above, “death taxes.” Marking the difference between taxes is important after death because some inheritances qualify for taxation from both.

Unlike an inheritance tax, where the beneficiary must pay for the inheritance exceeding the exemption limit. Estate taxes of an inheritance must be paid by the estate when its value surpasses the exemption limit. Both taxes are partially based on the overall value of the property. The estate is assessed before the distribution of inheritances, so most of the time, the estate “pays” its taxes.

Note: Estate taxes are property tax and death taxes, but they are also distinct from those. States that enact estate taxation can only do so when the estate exceeds $12.92 million. Further, estate taxation happens at the federal level, so properties exceeding $13 million are subject to steep tax percentages ranging from 18-40%.

Avoiding Inheritance Tax

Those looking to avoid an inheritance tax have options depending on the type of inheritance. In the case of property, taxation may occur depending on the type of real estate and presiding state laws. However, in the case of money, there are direct options:

  • Gift the money before death: the best way to avoid taxation is to give it all away.
  • Buy into an insurance policy: life insurance payable to a beneficiary is not taxable but may still fall under the estate tax rules above.
  • Set up an irrevocable trust: trusts are not accessible by taxation unless they are revocable, poorly written, or based on other elements of the inheritance process.

An Overview of Inheritance Taxation

When is inheritance taxable? When the inheritance surpasses a specific value determined by the local state government. Inheritance taxes are separate from estate taxes, although often bunched together. However, the regular person won’t encounter an inheritance tax. Read more about the world on our blog page, including legalese, asset management, taxation, and security.

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