What States Have Inheritance Tax? | Learn Step-By-Step

Last Updated on October 20, 2024 by Amrita Das

Although some countries have abolished inheritance taxes entirely, there are still many states in the United States that impose this tax on their residents. In this article, I will discuss with you what states have an inheritance tax and the various laws and regulations surrounding it.

Table of Contents

Understanding Inheritance Taxes

Inheritance taxes are state taxes that are paid by beneficiaries on the money or property they receive from a deceased person’s estate. Unlike federal estate taxes, which are paid by the estate itself, inheritance taxes place the responsibility on the beneficiary to pay the tax.

However, only six states currently have an inheritance tax in place, and even within those states, many beneficiaries may be exempt from paying it. This is due to factors such as certain exemptions and limitations set by each state’s laws.

Furthermore, Iowa has made moves towards phasing out its inheritance tax entirely by 2025. As such, while inheritance taxes may be a concern for some individuals, their impact may not affect as many people as other forms of taxation.

How Inheritance Tax Work?

Inheritance taxes are an important aspect of the distribution of assets after a person’s death. They are different from income tax, and their calculation is done separately for each individual beneficiary.

The executor of the estate distributes assets to the beneficiaries according to the deceased’s will.

Once this process is completed, inheritance tax comes into play. Each state has its own specific rules and regulations regarding inheritance tax, which can vary significantly.

For instance, some states may charge a flat rate on all inheritances, while others have a progressive system where the percentage increases as the value of the inheritance increases.

It is essential for beneficiaries to understand how these taxes work in their state and report them accurately on their inheritance tax form. By doing so, they can ensure that they are paying the correct amount and avoiding any potential penalties or legal issues.

What States Have An Inheritance Tax?

States with Inheritance Tax

While estate taxes are imposed on the overall value of a decedent’s estate, inheritance taxes are paid by the recipient of a bequest and are based on the amount distributed to each beneficiary. Currently, six states in the United States impose an inheritance tax:

Kentucky
New Jersey
Maryland
Nebraska
Iowa and
Pennsylvania

These states have different tax rates and exemption levels for inheritance taxes.

State Tax Rates and Exemptions

Among these six states with an inheritance tax, Kentucky and New Jersey have the highest top rate at 16 percent. Iowa is currently phasing out its inheritance tax with full repeal scheduled for 2025.

The District of Columbia has a top rate of 11.2 percent, while the remaining states have a top rate of 15 percent. All six states exempt spouses from inheritance tax, and some fully or partially exempt immediate relatives.

The exemption levels also vary among these states, with Oregon having the lowest exemption at $1 million and Connecticut having the highest at $12.92 million.

History and Changes in Inheritance Taxes

In 1926, the federal government began offering a state estate tax credit which made estate taxes an attractive option for states to collect revenue.

However, after the federal government phased out this credit, some states responded by repealing their inheritance taxes while others continue to impose it.

In recent years, most states have been moving away from inheritance taxes due to its impact on competitiveness and incentives for tax avoidance.

Some states, such as Delaware and Vermont, have completely abolished their inheritance taxes while others have raised exemption levels or are in the process of phasing it out.

Potential Reforms

In addition to the six states currently imposing an inheritance tax, other states like Oregon and Illinois have proposed increasing their exemption levels significantly.

This ongoing discussion shows that there is still a possibility for reforms in these remaining states with an inheritance tax.

Ultimately, estate and inheritance taxes can be burdensome for both taxpayers and the economy at large, therefore it may be beneficial for these states to consider gradually eliminating or conforming to federal exemption levels.

Overall, it will be important for these states to carefully evaluate the impact of their inheritance tax policies on their residents and their economy.

As the landscape of estate and inheritance taxes continues to evolve, it will be interesting to see if more states follow in the footsteps of those who have moved away from these types of taxes or if they continue to hold onto them as a source of revenue.

The potential for further reforms and changes makes this an important topic to watch in the coming years.

Additional Reading: What Is A Per Capita Tax? | An Informative Guide

How Is Inheritance Tax Calculated And Taxed?

Inheritance tax calculation can be a complex process as it varies depending on the state and the relationship between the beneficiary and the deceased.

Generally, states consider closer relationships such as spouses, children, or grandchildren to be exempt from paying inheritance taxes. This exemption is based on the belief that these individuals have a stronger claim to the assets of their loved ones.

For those who do have to pay inheritance taxes, it is usually applied to amounts above a certain threshold and may be subject to a flat rate or graduated scale.

This means that the more you inherit, the higher your tax rate may be. It is important to understand how inheritance taxes work in your state in order to properly plan for any potential tax implications when receiving an inheritance.

Overall, understanding the intricacies of inheritance tax calculation can help individuals navigate this aspect of estate planning and ensure that loved ones are able to receive their inheritances without being burdened by excessive taxes.

Overview Of Inheritance Tax Thresholds

Inheritance tax thresholds vary by state and dictate the amount that an individual can receive from a deceased person’s estate without having to pay taxes on it.

These thresholds are subject to change and exemptions may apply depending on the relationship between the recipient and the deceased.

State-by-State Breakdown of Inheritance Tax Thresholds

Iowa: Estates valued at less than $25,000 are exempt from inheritance tax. Spouses, lineal ascendants, lineal descendants, and charities are also exempt.
Maryland: Inheritances from estates smaller than $50,000 are exempt. Immediate family members and charitable organizations are also exempt.
Kentucky: Immediate family members are fully exempt while non-family recipients are exempt up to $500 or $1,000. The tax rate is based on a sliding scale and ranges from 4% to 16%.
Nebraska: Spouses and charities are fully exempt while immediate family members can receive up to $100,000 (as of 2023) without paying taxes. Other relatives and unrelated heirs have exemption limits of $40,000 and $25,000 respectively.
New Jersey: Immediate family members and charitable organizations are exempt. Siblings and sons/daughters-in-law have an exemption limit of $25,000.
Pennsylvania: Spouse and minor children are exempt while adult children, grandparents, and parents can receive up to $3,500 without paying taxes. The tax rate ranges from 4.5% to 15%, depending on the relationship.

Changes in Inheritance Tax Thresholds

Iowa is set to repeal its inheritance tax in 2025, which will bring significant changes for those who inherit property from loved ones.
Nebraska lowered its tax rates in 2023, with new rates of 1%, 11%, and 15%.

These changes reflect the constant evolution of inheritance tax laws and highlight the importance of staying informed about current thresholds and exemptions in your state.

What Is Estate Tax And How It Works?

Estate tax is a type of tax that is imposed on the transfer of an estate from a deceased individual to their beneficiaries. It is designed to ensure that the estate is properly managed and transferred to its rightful heirs.

The taxable amount is calculated by subtracting any outstanding liabilities from the net value of the estate, using the date of death as a reference point.

This means that any inheritance received by beneficiaries will be reduced by the amount paid in estate taxes.

While federal estate taxes are applicable to everyone, some states also have their own estate tax laws. Therefore, individuals need to understand their state’s regulations in addition to federal laws.

Understanding Estate Tax Vs Inheritance Tax

Estate tax and inheritance tax are two terms that are often used interchangeably, causing confusion among many individuals.

However, it is important to understand the key differences between these two taxes in order to properly plan for the future and avoid any surprises.

Where the Taxes are Paid

The first major difference between estate tax and inheritance tax lies in where the taxes are paid. Inheritance tax is only imposed at the state level, meaning it varies depending on which state you reside in.

On the other hand, estate tax is imposed both at the federal and state levels. This means that regardless of where you live if your assets surpass a certain threshold set by the federal government, your estate will be subject to estate tax.

Who is Responsible for the Tax

Another key difference between estate and inheritance tax is who is responsible for paying the tax. Inheritance tax is paid by the individual receiving the inheritance, while estate tax is paid by the estate itself before any assets are distributed to beneficiaries.

This highlights the importance of having an executor named in your will who can handle such financial matters on behalf of your estate.

Not All States Impose Inheritance Tax

Lastly, it’s important to note that not all states impose inheritance tax. Currently, only 6 states have an inheritance tax as I mentioned earlier paragraph.

If you reside in one of these states or receive an inheritance from someone living in these states, you may be subject to inheritance tax.

It’s crucial to research and understand the tax laws in your state in order to properly plan for any potential taxes that may need to be paid.

States subject to estate tax are:

Connecticut
Hawaii
Illinois
Maine
Maryland
Massachusetts
Minnesota
New York
Oregon
Vermont
Washington, D.C.
Washington

Tips For Minimizing Inheritance Taxes

Personal Exemptions for Inheritance Tax

In some states, certain individuals may be exempt from inheritance tax, such as spouses and children. This can greatly reduce or eliminate the amount of taxes owed on inherited property.
However, it’s important to note that each state has different laws regarding inheritance tax exemptions, so it’s best to consult with a tax professional for specific information.

Consider Relocating to Another State

If you live in a state that imposes inheritance taxes, one way to avoid them is by relocating to a state that doesn’t have this type of tax.
Before making any major decisions, it’s important to research the cost of living and other factors in the potential new state to determine if relocation would be beneficial solely for avoiding inheritance taxes.

Utilizing Irrevocable Trust Funds

Another strategy for avoiding inheritance taxes is by utilizing an irrevocable trust fund. This allows the assets to be placed in a trust that can be distributed to beneficiaries without going through the legal process of property transfer.
By setting up the trust before passing away, the individual can also have more control over how their assets are distributed and potentially reduce or eliminate inheritance taxes for their loved ones.

Other Considerations for Avoiding Inheritance Taxes

It’s important to keep in mind that inheritance tax laws and exemptions vary by state, so it’s crucial to consult with a professional familiar with your specific state’s regulations.
Additionally, certain types of property may not be subject to inheritance taxes, such as retirement accounts and life insurance policies.
Proper estate planning, including creating a will or setting up a trust, can also help minimize inheritance taxes for your beneficiaries.

Is Buying A Life Insurance Can Be Helpful To Avoid Inheritance Tax?

Buying a life insurance policy can be a great help against inheritance tax because death benefit payouts are usually tax-free. The heirs of the assets you leave behind can use these amounts to pay their inheritance tax or estate tax.

It is true that this policy does not reduce or eliminate your taxes but can play a significant role in reducing or paying your tax burden. Which means the heir does not have to pay out of the estate and can avoid this burden.

In addition, you can also make an irrevocable life insurance trust where premium payments can be made from the assets of the trust if your policy is retained.

After death the trustee will collect the life insurance money. They can use this money for funeral expenses and for distribution among the beneficiaries of the trust.

What Happens If You Receive Inherit From Non-US Person?

In most cases, beneficiaries pay no tax on an inheritance or estate received from a non-US citizen. But you may have to report these assets to the IRS. Perhaps in this case, a foreign inheritance may be taxed.

The IRS generally does not tax the decedent’s estate or you if you become a US person and receive assets from a non-US person. If the assets bequeathed are “US situs” the only exception might be.

This means that the asset is real property that is usually located in the United States. Suppose a non-US person offer a home in California to a US citizen then this asset qualifies as a US situs asset.

And in this case the property will be subject to a tax which can usually be 40 percent of its value. But assets that are no longer US situs are not subject to federal inheritance tax.

Learn More About US situs: https://altrolaw.com/blog-cross-border-estate-planning/us-situs-asset/

What States Have Inheritance Tax: Conclusion

With only six states currently imposing this tax, it may not affect many individuals; however, it is still important to understand its implications and plan accordingly.

Knowing the inheritance tax laws and rates in your state can help you make the right decisions about your estate planning and ensure that your loved ones receive the maximum benefit from their inheritance.

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