A Complete Guide on Inheritance Taxes

Inheritance taxes refer to the money that is paid on property or assets inherited after the death of the original owner. The tax is levied on the inherited assets, and it varies from one country to another. In this article, we shall focus on the inheritance taxes in the United States, but first, we need to understand the concept of inheritance.

What is Inheritance?

Inheritance is the process whereby the assets of a deceased person are passed down to their heirs or beneficiaries. The process involves a legal procedure called probate, where the court determines the validity of the will and appoints an executor to distribute the assets according to the will.

Probate includes the payment of the deceased’s debts and taxes, and any remaining assets are then distributed to the beneficiaries. The beneficiaries can either be named in the will or determined by the state laws of intestacy in the absence of a will.

What are Inheritance Taxes?

Inheritance taxes are assessed on the value of the inherited property, and they are paid by the beneficiary rather than the estate. Inheritance taxes are different from estate taxes, which are taxes levied on the entire estate before the assets are distributed to the beneficiaries. Inheritance taxes are only imposed on a few states in the US, and the amount of tax varies depending on the state.

Types of Inheritance Taxes

There are two types of inheritance taxes: state and federal inheritance taxes. Federal inheritance tax is levied on property or assets inherited from a non-spouse if the value exceeds $11.58 million for an individual or $23.16 million for a married couple in 2020. In other words, the tax only applies if the value of the inherited property exceeds these thresholds.

The federal inheritance tax rate ranges from 18% to 40%, depending on the value of the assets. For example, if the value of the inherited property is $12 million, the beneficiary is taxed on the excess amount of $420,000 (i.e., $12 million – $11.58 million) at a rate of 40%, resulting in an inheritance tax of $168,000.

However, in 2021, the federal government raised the threshold for the estate tax to $11.7 million for an individual or $23.4 million for a married couple. This means that the vast majority of estates will not face any federal estate tax liability.

On the other hand, state inheritance taxes are levied by only six states: Indiana, Nebraska, Iowa, Kentucky, Pennsylvania, and Maryland. These states have varying tax rates, exemptions, and other rules, which we will discuss in detail.

State Inheritance Taxes

1. Indiana Inheritance Tax

Indiana abolished its estate tax, which means that the estate, not the beneficiaries, pays the tax. However, the state still has inheritance tax, which is paid by the beneficiaries. The tax rate ranges from 1% to 10%, depending on the value of the property inherited and the relationship of the beneficiary to the deceased. The higher the value, the higher the tax rate. Also, the closer the relationship, the lower the tax rate.

For example, spouses, children, and stepchildren of the deceased do not have to pay any inheritance tax. However, siblings and nieces or nephews are taxed at a rate of 10%. Unrelated beneficiaries are taxed at the same rate as a sibling, except for charities, which are exempt.

2. Nebraska Inheritance Tax

Nebraska has an inheritance tax that ranges from 1% to 18%, depending on the value of the property inherited and the relationship of the beneficiary to the deceased. The closer the relationship, the lower the tax rate.

Spouses, children, grandchildren, parents, grandparents, and siblings of the deceased are exempt from inheritance tax. However, the tax rate is 10% for nieces, nephews, aunts, uncles, and cousins. Unrelated beneficiaries are taxed at a rate of 15% to 18%.

3. Iowa Inheritance Tax

Iowa has an inheritance tax that ranges from 0.5% to 15%, depending on the value of the property inherited and the relationship of the beneficiary to the deceased. The closer the relationship, the lower the tax rate.

Spouses, children, grandchildren, parents, grandparents, and siblings of the deceased are exempt from inheritance tax. However, the tax rate is 10% for nieces, nephews, aunts, uncles, and cousins. Unrelated beneficiaries are taxed at a rate of 5% to 15%.

4. Kentucky Inheritance Tax

Kentucky has an inheritance tax that ranges from 0% to 16%, depending on the value of the property inherited and the relationship of the beneficiary to the deceased. The closer the relationship, the lower the tax rate.

Spouses, children, grandchildren, and parents of the deceased are exempt from inheritance tax. However, the tax rate is 4.5% for siblings, 6% for nieces and nephews, and 16% for unrelated beneficiaries.

5. Pennsylvania Inheritance Tax

Pennsylvania has an inheritance tax that ranges from 0% to 15%, depending on the value of the property inherited and the relationship of the beneficiary to the deceased. The closer the relationship, the lower the tax rate.

Spouses and children under the age of 21 are exempt from inheritance tax. Children who are disabled or under the age of 18 are also exempt. The tax rate is 4.5% for siblings, 12% for nieces and nephews, and 15% for unrelated beneficiaries.

6. Maryland Inheritance Tax

Maryland has an inheritance tax that ranges from 0% to 10%, depending on the value of the property inherited and the relationship of the beneficiary to the deceased. The closer the relationship, the lower the tax rate.

Spouses, children, grandchildren, and parents of the deceased are exempt from inheritance tax. However, the tax rate is 10% for nieces, nephews, and other beneficiaries. Unrelated beneficiaries are taxed at a rate of 10%.

Conclusion

Inheritance taxes are not as common as they used to be, but they are still in place in several states. The amount of tax, the exemptions, and the tax rates vary from one state to another, and it’s essential to understand the laws of the state where the property is located.

It’s important to note that while inheritance taxes may seem daunting, there are plenty of ways to minimize them. Talk to an estate planner or tax professional who can help you understand the best strategies for your particular situation.

Inheritances taxes are either collected from an estate of from the individual that inherits from the estate. Like other taxes, inheritance taxes are determined as a percentage of the total value of an estate, on the day that an individuals inherits from the estate. In some cases, an inheritance tax is also known as an estate tax. In the United States, there is a distinction between an inheritance tax and an estate tax. An estate tax is generally the tax imposed on the actual estate, before anyone inherits from the estate. Whereas, an inheritance tax is imposed on the individuals that inherit from an estate. The inheritance tax would generally be calculated on the vale of inherited property, on the day that an individual inherits said property, or the day that the benefactor
passes away.

Some states impose an inheritance tax on the beneficiaries of an estate, while others do not.  There are also jurisdictions that impose both an inheritance and an estate tax. While some states impose an inheritance tax, the federal government imposes an estate tax. The estate tax is set to expire in 2010 and it is difficult to ascertain what may result from the expiration of the estate tax. Many States have begun to allow their inheritance tax statutes to lapse or expire. However, the federal government is not likely to allow the
estate tax to expire. The expiration could result in Congress passing an estate tax that could be levied against a larger percentage of assets. In fact, many members of the tax reform movement believe that is likely to happen. However, the lapse could also result in a lowered percentage of estate taxes, or a complete lack of an estate tax. Although the tax may expire, that does not mean that the government cannot in fact, tax an estate afterwards.  Beneficiaries are likely to be in tax limbo until the issue is resolved by Congress. Yet, beneficiaries are likely to be aware of what their inheritance tax burden will be in their state.

In most jurisdictions, an inheritance tax is dependent on the type of assets and property that an individual inherits. Another factor in inheritance taxes is the beneficiaries relationship with the deceased. Generally, the closest relatives, children and parents, are taxed at a lower rate than other beneficiaries.  In most cases, beneficiaries will be responsible for an inheritance tax burden based on the total value of inheritance. Inheritances tax burdens can end up being a large percentage of inherited property. Often, those percentages are determined based on the size of an estate. Like many tax brackets, inheritances tax percentages tend to increase with the size, or value, of an estate.