What is inheritance tax?

Definition:

Inheritance tax is a tax imposed by the state on heirs and beneficiaries who receive property from a deceased person’s estate. The tax is usually a percentage of the value of what they receive, based on their degree of relationship to the deceased.

How does inheritance tax work?

Inheritance tax is levied on individual gifts, not on the entire estate, by the state in which the deceased lived or where the property was owned. Some individuals include provisions in their estate plans or wills that the inheritance should bear the tax costs on behalf of the beneficiary.

Tax rates are usually graduated, with spouses exempt and distant relatives and non-relatives paying the highest rates. Some states also exempt taxes on direct descendants.

The states of Maryland, New Jersey, Pennsylvania, Kentucky, Iowa, and Nebraska imposed inheritance taxes until 2022. The tax rates usually vary based on the degree of kinship between the deceased and the beneficiary. The lowest tax rates, for example, in Pennsylvania, are for inheritances passed to the surviving spouse or to a parent from a child who was 21 years old or younger. Charitable organizations that benefit may be exempt from the tax.

Example of inheritance taxes

If your father, who lived in New Jersey, left you $25,000, you would not be required to pay tax on that money. If he left you $500,000, the first $25,000 would be tax-free, and you would pay an 11% tax on $475,000 of your inheritance. The inheritance tax you would owe to the state of New Jersey would be $52,250.

Inheritance tax vs. estate tax

Inheritance tax is not the same as estate tax, even though both are commonly referred to as “death taxes.” Estate tax is levied on the entire estate, and the responsibility for paying the required taxes falls on the estate, while generally the beneficiary of the inheritance pays the inheritance tax.

Twelve states and the District of Columbia levy estate taxes as of 2022. Only the state of Maryland has both inheritance and estate taxes.

Do I need to pay inheritance tax?

You will not have to pay inheritance tax even if you live in a state that imposes this type of tax, as long as the deceased did not live and die in that same state as well. However, there is an exception to this rule if you inherit real estate located in a state that imposes inheritance taxes. The tax is applied by the state of residence of the deceased and the location of the property. You will not be responsible for inheritance tax unless the person who left you the money lived in one of the six states that are subject to the tax and the value of your inheritance exceeds the allowable limit for taxation.

For example, you would not have to pay inheritance tax in New Jersey if you lived there but your brother, who lives in New York, left you $500,000 in his will. However, your brother’s estate may be subject to other taxes at the state or federal level. If the situation were reversed (you live in New York and your brother lives in New Jersey), the amount your brother left you of $500,000 would be subject to inheritance tax in New Jersey.

Takeaway

As of 2022, inheritance tax is imposed by six states on the value of individual gifts given to beneficiaries. The federal government does not impose taxes on inheritances. The beneficiary, not the estate, is responsible for paying the inheritance tax, but some estate planning strategies allow the estate to pay the tax on behalf of the beneficiary. Consult a local accountant or estate planning attorney if you think you may be subject to inheritance tax because the rules can vary somewhat by jurisdiction.

Source: https://www.thebalancemoney.com/definition-of-inheritance-tax-3505560