What is an inheritance tax?
Inheritance tax is a state tax on assets inherited from someone who died. For federal tax purposes, inheritance generally isn’t considered income. But in some states, an inheritance can be taxable. The person who inherits the assets pays the inheritance tax, and tax rates vary by state.
Most of the time, only big estates feel the bite of taxes — odds are you won’t have to pay them. But there are exceptions, and the specifics of your inheritance tax situation can dramatically change your tax bill.
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Is inheritance tax the same as estate tax?
Inheritance tax and estate tax are two different things. Estate tax is the amount that’s taken out of someone’s estate upon their death, while inheritance tax is what the beneficiary — the person who inherited the wealth — must pay when they receive it. One, both, or neither could be a factor when someone dies.
The estate tax is a tax on a person's assets after death. In 2021, federal estate tax generally applies to assets over $11.7 million, and the estate tax rate ranges from 18% to 40%. Some states also have estate taxes (see the list of states here) and they might have much lower exemption thresholds than the IRS. Assets that spouses inherit generally aren't subject to estate tax.
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Inheritance tax is a state tax on assets inherited from someone who died. The person who inherits the assets pays the inheritance tax.
The rules vary by state regarding estate size and asset types that are subject to inheritance tax. Often, the deceased’s spouse and children are exempted, meaning money and items that go to them aren't subject to inheritance tax.
States that have an inheritance tax
Because the estate tax and inheritance tax are different, some people can get hit with a double whammy. Maryland, for example, has an estate tax and an inheritance tax, which means an estate might have to pay the IRS and the state, and then the beneficiaries might have to pay the state again out of what’s left. However, as you'll see below, this isn't the norm across the country.
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States that levy an inheritance tax include:
And here are the states that have estate taxes, inheritance taxes or both:
Is inheritance taxable income?
In most cases, assets you receive as a gift or inheritance aren't taxable income at the federal level. However, if the assets you inherit later produce income (perhaps they earn interest or dividends, or you collect rent), that income is probably taxable.
How to avoid inheritance tax
There are a few ways to minimize the tax bite on handed-down assets.
One common element of estate planning is to give assets away before dying. Many states don’t tax gifts. (Learn how the gift tax works.)
Gifts don’t have to be cash — stocks, bonds, cars or other assets count, too.
Getting help from a qualified tax expert can be key.
Beneficiaries can only do so much to avoid inheritance taxes once they’ve inherited an estate. However, those leaving the estate can take steps ahead of time to ensure beneficiaries are in the best situation possible. These estate-planning vehicles include living trusts, irrevocable trusts and grantor retained annuity trusts.
Watch out for capital gains tax
If assets appreciate after you inherit them, you might need to pay capital gains tax if you sell the assets.
The capital gains tax rate is based on, among other things, the profit you make. For example, if your father leaves you a stock portfolio worth $200,000 on the day he died, and you sell it all for $350,000 two years later, you might owe capital gains tax on the $150,000 gain.
Certain types of inheritances might also create taxable income. For example, if you inherit an IRA or 401(k), the distributions you take might be taxable.
States might have their own capital gains tax rules, so it's a good idea to seek qualified advice.
There are strategies to reduce capital gains taxes that could be a consideration.
Some helpful links from the IRS: