Inheritance Tax: What It Is and How It Works
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If a loved one passes away and leaves you an expensive asset or large sum of money, you might worry about paying inheritance tax. The good news is that there’s no federal inheritance tax in the US, and very few states levy this tax. For this reason, it’s unlikely to become a tax burden for most Americans.
But if you live in one of the few states that do, it’s helpful to know how inheritance taxes work, who is responsible for paying them, and any exemption thresholds.
In this article
What is an inheritance tax?
An inheritance tax is a tax imposed on assets or money inherited from someone who passed away. Common types of inheritances include money, houses, real estate, cars, and other valuables.
This tax is paid by the person receiving the inheritance, and your state determines the exact inheritance tax rates. If you are charged an inheritance tax, you must pay this expense within months of receiving the inheritance.
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How do inheritance taxes work?
The beneficiary of an asset or estate owes inheritance taxes. If you live in a state that levies inheritance tax, you’ll pay this tax at the state level shortly after receiving your inheritance.
Not every asset is subject to inheritance tax. Some inheritances, like a life insurance policy, are typically exempt from taxation.
In some cases, an asset you inherit may be considered taxable income (like an inherited retirement account). If you take distributions from the plan, your withdrawals would be taxable. You may not have to pay an inheritance tax on an annuity, but you will pay a tax on any withdrawals.
What is estate tax?
Unlike inheritance tax, estate tax is taken out of a person’s estate once they die. You can be charged both federal estate tax and state estate tax. There are estate tax exemption thresholds, however. By federal law, the Department of Revenue exempts $13.61 million over your lifetime as of 2024.
An estate tax is levied on the value of the decedent’s estate. It’s sometimes referred to as “death tax” since it’s imposed after a person passes away.
Related:
How much will you pay in inheritance tax?
The amount you’ll be charged in inheritance tax is based on the inherited asset’s fair market value. The exact tax rate a beneficiary will need to pay will also depend on the state they live in.
States that charge inheritance tax and estate tax
There is no federal inheritance tax in the US, but certain states levy this tax. Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania all charge state inheritance tax. However, Iowa will no longer have an inheritance tax after January 1, 2025.
Other states may also impose an estate tax. The federal estate tax ranges between 18% and 40% for assets over $13.61 million.
Here’s a quick look at which states charge inheritance and estate taxes.
State | Inheritance Tax | Estate Tax |
Alabama | No | No |
Alaska | No | No |
Arizona | No | No |
Arkansas | No | No |
California | No | No |
Colorado | No | No |
Connecticut | No | Yes |
Delaware | No | No |
Florida | No | No |
Georgia | No | No |
Hawaii | No | Yes |
Idaho | No | No |
Illinois | No | Yes |
Indiana | No | No |
Iowa | Yes, until 2025 | No |
Kansas | No | No |
Kentucky | Yes | No |
Louisiana | No | No |
Maine | No | Yes |
Maryland | Yes | Yes |
Massachusetts | No | Yes |
Michigan | No | No |
Minnesota | No | Yes |
Mississippi | No | No |
Missouri | No | No |
Montana | No | No |
Nebraska | Yes | No |
Nevada | No | No |
New Hampshire | No | No |
New Jersey | Yes | No |
New Mexico | No | No |
New York | No | Yes |
North Carolina | No | No |
North Dakota | No | No |
Ohio | No | No |
Oklahoma | No | No |
Oregon | No | Yes |
Pennsylvania | Yes | No |
Rhode Island | No | Yes |
South Carolina | No | No |
South Dakota | No | No |
Tennessee | No | No |
Texas | No | No |
Utah | No | No |
Vermont | No | Yes |
Virginia | No | No |
Washington | No | Yes |
West Virginia | No | No |
Wisconsin | No | No |
Wyoming | No | No |
If you are not exempt from paying inheritance taxes, you can use online calculators to help determine how much you might owe in them.
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Are there exemptions to inheritance tax?
Depending on your relationship with the deceased person, you may not have to pay inheritance taxes, even if your state imposes this tax. Surviving spouses are exempt from paying inheritance tax, regardless of where they live.
Other family members, like immediate relatives, parents of the deceased, children, and siblings, are often exempt from a certain amount. However, your tax liability will depend on your state’s laws.
Can you avoid paying inheritance tax?
Other options exist if your relationship with a decedent doesn’t exempt you from paying inheritance tax. In some cases, you may be able to avoid paying inheritance tax, even if you live in a state that charges this tax. To start, you should seek an experienced tax professional, attorney, or financial advisor to review your situation.
For example, if the asset you inherited was given as a gift before someone passed, you may be exempt from paying inheritance tax. Most states don’t impose gift taxes, but there are exceptions to some of these tax rules.
However, if you’re the beneficiary of an inheritance after someone passes, it’s harder to get around estate tax laws. That’s why it’s a good idea to work on estate planning before your loved ones pass, to ensure all inherited assets that will be passed down are handled correctly. Different types of contracts can be set up to protect beneficiaries and the decedent (the person who passed on), including living and irrevocable trusts.
Capital gains and inheritance tax
If a property or asset you inherit appreciates after you become its owner, you’ll likely have to pay capital gains tax to the federal government if you decide to sell it.
Your capital gains rate is determined by how much you profit and will be due when you file your tax return for the year.
Inheritance tax vs estate tax
Inheritance tax and estate tax are both forms of taxation imposed on the transfer of assets from a deceased person to their beneficiaries, but they operate slightly differently:
Purpose
Inheritance tax is imposed on the assets inherited by the beneficiaries of a deceased person's estate. On the other hand, estate tax is imposed on the overall value of a deceased person's estate before it is distributed to beneficiaries.
Tax liability
The tax liability for inheritance tax is typically based on the value of the assets received by each individual beneficiary. In the case of estate tax, the tax is calculated based on the estate's total value, including all assets and properties owned by the deceased at the time of death.
Tax rates and exemptions
The tax rates and exemptions can vary widely depending on the jurisdiction. Like inheritance tax, estate tax rates and exemptions vary by jurisdiction.
Exemption limits
Some jurisdictions may exempt certain assets or provide deductions or credits for certain types of beneficiaries, such as spouses or charitable organizations, from inheritance tax. On the other hand, estate tax often has a higher exemption threshold than inheritance tax, meaning it only applies to larger estates.
FAQs
Is inheritance tax the same as gift tax?
No, inheritance tax is levied on an asset left to a beneficiary. Only some states charge inheritance tax and if it’s required, it’s paid by the beneficiary shortly after the previous owner’s death.
Gift tax, however, is the taxation of an item, like property, passed from one person to another while the owner is still alive. Few states levy gift tax, and if a gift’s value is below federal government thresholds, it could remain tax-free. If you receive a gift that’s subject to taxation, you generally have to pay the IRS in the same tax year when you file your income taxes.
Can estate planning help you avoid inheritance tax?
Yes, proper estate planning can help prevent or minimize what a beneficiary will pay in inheritance tax. In some cases, giving an asset to a beneficiary before the owner dies will help circumvent inheritance tax.
However, the estate may still need to pay estate taxes, depending on the asset’s value and the state where the estate is located.
What is death tax?
Death tax is another name for estate tax. It’s a tax that’s levied on a person’s assets after they pass. Estate taxes are paid by the estate and not beneficiaries.
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The bottom line
In summary, the main difference between inheritance and estate tax is when the tax is imposed and on what basis it is calculated. Inheritance tax is imposed on the beneficiaries based on the assets they receive. In contrast, the estate tax is imposed on the overall value of the deceased person's estate before distribution to beneficiaries. However, "inheritance tax" and "estate tax" are sometimes used interchangeably depending on the country or region.
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Writer
Courtney Johnston is a freelance writer, specializing in finance, travel, and health. She has written for The Chicago Tribune, Benzinga, BestReviews, Mashvisor, Fundera, MoneyGeek, and The Culture Trip. She also teaches writing instruction at the University of Indianapolis. Courtney currently resides in Indianapolis.
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