As sad as it is, there always comes a time where a family member passes away. And what if this person left you some assets? You may be wondering what happens before they’re passed into your hands. Here’s everything you need to learn about inheritance tax, including what it is and if it will ever apply to you.
What Is Inheritance Tax?
So first, let’s talk about what this tax is and what you should know. Basically, an inheritance tax requires the beneficiaries to pay taxes on assets that they’ve inherited from someone who has died.
Now, before we get too far into this, inheritance tax is usually referred to as estate tax. And, the terms are used interchangeably. But they’re actually two completely different things.
What’s The Difference Between Inheritance Tax & Estate Tax?
Known as a “death tax”, estate taxes are taxes on someone’s right to transfer ownership of their entire estate to their loved ones when they die. If the value of these assets is higher than the federal estate tax exemption, the property can and may be subject to federal estate tax. In 2020, the tax exemption amount was $11.58 million for singles and $23.16 million for married couples.
States also have their own exemption thresholds. Estate taxes are deducted from the property before a beneficiary can claim it. So that means the money will be taxed long before you receive it.
But with inheritance taxes, the beneficiary is responsible for paying taxes if applicable. And while some states have estate taxes, you’ll never pay federal taxes on inheritance tax.
- life insurance,
- liquid cash, and
- other assets…
…can be subject to both taxes, depending on where you live and how much you receive. So, it’s important to talk to a lawyer and financial expert that are knowledgeable in that area.
Taxes On Inheritances
While there isn’t any inheritance tax from a federal perspective, some states do charge an inheritance tax. This is assessed by the state in which the inheritor is living (aka where you are living).
If you live in the states of Iowa, Kentucky, Maryland, Nebraska, New Jersey, or Pennsylvania, you may owe this tax. This depends on your relationship with the deceased as well.
Below are the current laws of the state in regards to inheritance tax:
- Iowa: Immediate family (children, spouse) are exempt (any amount). Inheritance tax for other recipients after $25,000.
- Kentucky: Immediate family (children, spouse, grandchildren, nieces, and nephews) are exempt. Inheritance tax for other recipients after $25,000 (4-16% depending on recipient relation).
- Maryland: Immediate family and charities exempt. Other recipients exempt up to $1,000 and after that, the inheritance tax is 10%.
- Nebraska: Spouse and charities exempt. Other recipients exempt up to $10,000-$40,000 depending on the relation. Inheritance tax after the threshold is 1% for other family members and 13-18% of other recipients.
- New Jersey: Immediate family (spouse and children) and charitable organizations exempt. Other recipients are charged 11%-16%.
- Pennsylvania: Spouses and charities exempt. Certain family members exempt up to $3,500, and then owe 4.5%. Other recipients are charged 12%-15%, with no exemption.
Remember, it is possible to pay both inheritance tax and estate tax. While estate tax is automatically taken out, you’ll have to calculate your inheritance tax if you live in one of the above states.
What Happens If There Is A Will or Trust?
While a will doesn’t exclude you from paying inheritance tax (if applicable), there are legal ways to reduce it or avoid it altogether.
One option is getting the inheritance as a “gift” instead of an inheritance. In 2020, anyone can give another person up to $15,000 within the year and avoid paying a gift tax. If you know your relative or friend is planning on leaving you money, this could be a good option. However, this needs to be approached correctly. Don’t just ask for the money “just because”.
Something else that can be done is a revocable trust could be set up. All beneficiaries therefore wouldn’t be subject to inheritance taxes.
Keep in mind, a revocable trust means that whoever put their assets into it can take them back out if necessary. So this may, or may not, work in your favor as a beneficiary.
How To Save Money On Taxes
Other than the two exemptions in the section above, other ways to make sure your beneficiaries (or you) can save money on inheritance tax include:
- Passing the money to a spouse, since most spouses are exempt (you should only have to do this if you live in a state that charges inheritance tax)
- Giving everyone the money up to the exemption limit (if not a spouse). You could spread this out across multiple beneficiaries as well.
- Donating money to charity, if applicable. This could work if you don’t want your children or other family members to pay penalties after a certain amount. This could *also* be a tax deduction for your spouse. Although it’s important to get clarity on that from a professional.
Inheritance Tax: Last Words
As you can see, the inheritance tax isn’t that bad. In fact, for the most part, you may not have to pay it at all. As usual, it’s important to get the opinions of a professional before you use the money that was given to you. However, you shouldn’t have to worry about paying this tax as a beneficiary if you don’t live in the above states.
Do you have other thoughts about the inheritance tax? Leave a comment below!
AUTHOR Kimberly Studdard
Kim Studdard is a project manager for online entrepreneurs and small businesses. When she isn't spending time with her daughter and husband, or reading her growing pile of horror books, you'll find her working on her HR degree and working towards FIRE.