What taxes do you have to pay on an inheritance?
The death of a loved one is always a difficult time. The last thing most people want when they are in mourning is to have to deal with the IRS and state tax officials. Yet, unfortunately, the inheritance and inheritance tax rules in many places require at least some tax planning thought.
There is a lot of confusion about how and when people who inherit someone’s property should pay the taxes. Below, we’ll go over several key rules to help you determine when you might have to pay taxes on an inheritance.
There is no federal inheritance tax
The first rule is simple: if you receive property in an inheritance, you will not owe any federal tax.
This is because federal law does not charge any inheritance tax directly to the heir. This is similar to handling gifts, as gift recipients do not have to federal donation tax, Is.
Federal inheritance tax can reduce your inheritance before you get it
But that doesn’t mean that taxes can’t affect how much you inherit. Property taxes apply at the federal level. They are charged directly to the estate, forcing the estate’s personal representative to use cash or sell estate assets to pay tax.
In the absence of text in a will or trust to the contrary, federal estate tax liability does not generally affect specific bequests in cash or property to beneficiaries. Instead, those who receive whatever property remains after specific bequests are made end up receiving less than they would in the absence of the inheritance tax.
Fortunately, there is a relatively high exemption from federal inheritance tax. Up to $ 11.58 million can be transferred to heirs without any federal inheritance tax, although state property taxes in some states, they are considerably lower and may apply even when federal estate tax does not.
If the estate wrongly fails to pay any inheritance tax owed, the IRS has the power to collect from heirs. Technically, however, this is not an inheritance tax, but rather a collection of inherited assets that should never have been distributed from the estate in the first place.
State inheritance taxes
Most states also don’t charge inheritance tax. But six states have royalties that apply to heirs: Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania.
The rules for each of these states differ. But they have many similarities:
- Some family members will not have to pay inheritance tax at all. For example, in Iowa, a surviving spouse, parents, grandparents, children, grandchildren, and other linear ascendants and descendants are exempt.
- Tax rates tend to be lower for close family members and higher for those with more distant family connections or not. For example, in New Jersey, the deceased’s siblings and stepchildren get an exemption of $ 25,000 before an initial rate of 11% applies. However, more distant family members like cousins do not benefit from any exemption and pay an initial rate of 15%.
- Inheritance tax generally applies in two cases: when the deceased person lived in the state that charged the inheritance tax, or when a non-resident owned property in that state. You may also owe inheritance tax if the deceased lived in another state that also charges inheritance tax, as some states have complicated rules on how to divide the responsibility for inheritance tax in these cases.
How to avoid inheritance tax
The heir has very little power to avoid inheritance tax. The only good way to avoid them is for the person leaving the bequest to plan the inheritance rights before death.
Specifically, a person wishing to bequeath property to a loved one without triggering inheritance taxes might consider donating before their death rather than by will or trust. Most states that apply inheritance tax have rules that prevent someone from making such gifts immediately before death. But if the person builds a history of regular giving, there is a better argument that these gifts should not be treated as if they contemplate death and therefore potentially subject to inheritance tax.
Know the rules
No one wants to have part of a legacy taken away through taxes. Most people don’t have to deal with inheritance tax, but those with family in states that have these tax provisions on the books should be aware of them and their potential impact.