When a loved one passes away, they sometimes leave money or assets to someone through a will. While inheritance isn’t taxed like income, that doesn’t mean it’s completely tax-free. You have an obligation to pay certain federal and state taxes that cover any gains you received. This overview will help you understand inheritance laws to figure out what you owe.
Inheritance vs. Estate Tax
You may know that estate taxes are paid when assets are passed on after a loved one dies. However, inheritance and estate taxes are very different. Estate taxes are quite high and are levied on the total value of a deceased person’s money and property. The amount is paid out of the decedent’s assets before any distribution to beneficiaries. The estate tax limit is very high, so that very few people reach the limit where they’re required to pay an estate tax.
Alternatively, an inheritance tax is paid by the person that receives the inheritance. This makes the beneficiary of the property is responsible for paying the tax, not the estate. Since the state charges an inheritance tax, not every amount has the same laws. Additionally, some states don’t require state inheritance taxes.
How Inheritance Tax Works
After someone passes, an executor has the job of passing out the estate and following through with the individual’s will. The assets are distributed among the beneficiaries, and the inheritance tax is required if you live in a state with inheritance tax. The amount is calculated separately for each recipient, and each one must pay the tax if necessary.
For example, let’s say the state charges a 5% tax on all inheritance larger than $2 million. Your loved one may leave you an inheritance of $5 million in the will. You are required to pay taxes on $3 million of the money, which would be $150,000. Under $2 million may not require a state inheritance tax payment.
States with Inheritance Taxes
As mentioned above, only certain states have a state inheritance tax. For now, only Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania require beneficiaries to pay a state inheritance tax, according to TurboTax. Of course, state laws can change, so it’s important to research whether your state still has the tax.
Depending on your relationship with your loved one, you may even be eligible for an exemption. State inheritance tax laws are known to have many exemptions. For example, most states exempt a spouse from the tax when they inherit property or assets from another spouse.
Additionally, children and other dependents may qualify for the same tax exemption in some cases. Other times, only a portion of the inheritance may be taxable, leaving the rest untaxed. Generally, a higher rate of taxes is imposed on those who don’t have a familial connection with the person passing on the inheritance.