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Inheritance Tax: Which States Have One & Whether You’ll Owe in 2020-2021

There's a big difference between inheritance tax and estate tax, and whether you pay might come down to where you live.
Nov. 14, 2020
Estate Planning, Income Taxes, Personal Taxes, Taxes
Find Out If You'll Have to Pay Tax on an Inheritance
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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.

Some tax rules have changed due to coronavirus

Learn more about what's different for taxpayers as part of the federal government's response to the coronavirus.

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. Tax rates vary by state.

» MORE: Learn what to do about an inherited IRA

Do you have to report inheritance money to the IRS?

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 likely taxable. IRS Publication 525 has the details.

Is inheritance tax the same as estate tax?

Inheritance tax and estate tax are two different things. Estate tax comes out of the deceased’s pocket. Inheritance taxes come out of the beneficiary’s pocket. One, both or neither could be a factor when someone dies.

Estate tax

The estate tax is a tax on a person’s assets after death. In 2020, federal estate tax generally applies to assets over $11.58 million; in 2021 it’s $11.7 million. 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. IRS Publication 559 has the details.

Inheritance tax

Inheritance tax is a state tax on assets inherited from someone who died. The person who inherits the assets pays the inheritance tax. Iowa, Kentucky, Maryland, Nebraska, New Jersey and Pennsylvania tax people who receive inheritances, according to the American College of Trust and Estate Counsel.

  • 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.
  • Some people can get hit with a double whammy. Maryland 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.

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.

 

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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.

Find more ways to secure your assets and your future