What Is Inheritance Tax and Can You Avoid Paying It?

What Is Inheritance Tax?

An inheritance is an asset whose ownership is passed to you after someone dies. While some inheritances are cash, you can also inherit stocks, bonds, cars, jewelry, art, antiques, real estate, and other tangible assets. When you inherit an asset, you might have to pay taxes on it. Inheritance tax is different from other types of taxes you usually pay because you’re paying taxes on money or assets that weren’t originally yours.

When someone dies, you might hear about an estate tax being charged. Even an estate tax is different from an inheritance tax. An estate tax is charged to the value of the decedent’s assets before the assets are distributed to the rightful beneficiaries. An inheritance tax is what’s potentially charged to the beneficiaries once they receive the assets.

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Do You Have to Pay Taxes on Inherited Assets?

You may have to pay an inheritance tax if someone leaves their assets to you. If you’re the spouse of the person who passed away, you’re exempt from paying an inheritance tax. If you’re another type of relative or a friend of the decedent, your potential inheritance tax depends on the state laws. Whether or not you have to pay taxes on inherited assets is determined by where the decedent lived, your relationship to the decedent, the value of the assets, and other factors that are decided at the state level.

How Much Is Inheritance Tax?

Because there’s no federal inheritance tax rate, how much you’ll have to pay for inherited assets depends on the state’s laws and rates. These rates and tax laws can change annually, so it’s important to check with your decedent’s state before taking ownership over inherited assets. There might be exemptions you qualify for depending on age and filing status. Specially categorized organizations may have some exemptions and special laws regarding inheritance tax in the state as well.

Which States Have Inheritance Tax?

It’s important to know that not all states have inheritance tax laws. As of June 2022, you may have to pay inheritance tax on assets if your decedent lived in one of the following six states:

• Maryland. If your loved one passed way after July 1, 2000, you don’t have to pay inheritance tax if you’re a lineal descendant, such as a spouse, child, parent, grandparent, stepchild, stepparent, or sibling. In Maryland, if you have a different relationship to the decedent, you might be responsible for paying an inheritance tax of up to 10% of the asset’s value.
• Nebraska. The surviving spouse is exempt from paying an inheritance tax in Nebraska along with some qualifying charitable organizations. Close relatives of the decedent, like parents, grandparents, siblings, children, grandchildren, and any of those relatives’ spouses, have to pay 1% in taxes toward any asset that’s valued over $40,000. If you don’t fall in the “close relatives” group and are a less immediate family member of the decedent, you may be responsible for an inheritance tax rate of 13% for assets that are valued over $15,000. If you’re not a family member or qualifying organization, you’ll have to pay a tax rate of 18% for inherited assets in Nebraska.
• Kentucky. In Kentucky, the closer your familial relationship is to the decedent, the lower your inheritance tax rate. There are three classes of family beneficiaries in this state. Class A is exempt from paying inheritance tax, and this class includes the surviving spouse, parents, children, grandchildren, siblings, and half-siblings. Class B includes nieces, nephews, half-nieces, half-nephews, children-in-law, aunts, uncles, and great-grandchildren. If you fall in the Class B beneficiary list, you may have to pay 4% to 6% in taxes for assets that are valued over $1,000. Cousins, nieces and nephews by marriage, and all other beneficiaries not included in Class A or B fall in the Class C category. If you’re a Class C beneficiary, you might be subject to pay 6% to 16% in taxes for assets valued over $500.
• New Jersey. If the decedent lived in New Jersey, the inheritance tax rate depends on your relationship to them along with the valued amount of the assets they left you. Immediate relatives, like the surviving spouse, children, parents, and siblings, are exempt from inheritance taxes no matter what the value of the assets are. However, other relatives can expect to pay up to 16% in taxes depending on how much the assets are worth.
• Pennsylvania. The surviving spouse, children under 21 years old, and some charitable organizations are exempt from paying inheritance taxes in Pennsylvania. Other lineal relatives are subject to a 4.5% tax rate. Siblings may pay up to 12% in inheritance tax on assets they receive. Other heirs may pay up to 15% in inheritance tax.
• Iowa. If your loved one lived in Iowa at the time of their passing, this state might impose one of two inheritance tax rates. The spouse and children are exempt from both tax rates. However, siblings, half-siblings, and children-in-law may have to pay 5% to 10% in inheritance tax. Foster children, uncles, aunts, nieces, nephews, cousins, siblings-in-laws, and other beneficiaries may pay anywhere from 10% to 15% in inheritance tax. Because of recent changes in Iowa’s laws, your inheritance tax rate might be reduced depending on what year your loved one passed away.

How Can You Avoid Being Taxed for Inherited Assets?

If you’re not the surviving spouse or a close relative of the decedent, the best way to avoid getting taxed for your inherited assets is to handle your affairs before your loved one passes away. If given the opportunity, ask your loved one to consider gifting you the asset instead of leaving it to you. Most states don’t have gift tax rates, so you can receive the asset without having to pay taxes on its value.

If your loved one doesn’t gift you the asset, you may be required to pay inheritance tax if they lived in one of the six states mentioned in this article. Contact the state’s office for updated laws and inheritance tax rates. Speak to an accountant or financial attorney that can answer your state-specific questions about paying inheritance taxes on assets left to you. Explore the Microsoft 365 Life Hack’s Budgeting hub for more tips and overviews on more financial topics related to taxes, investing, and budgeting.