When you receive an inheritance from a loved one or relative, there is a possibility that you may need to pay an inheritance tax. This tax only occurs in some states, but there may be ways you can avoid the inheritance tax. The federal government does not impose a tax on inheritances.
It may be necessary for the Executor of the estate to pay estate taxes before distributing any of the assets to the heirs. The federal government charges an estate tax, and some states also do. These taxes are paid out of the estate before money or assets are given to the beneficiaries.
States With an Inheritance Tax
Right now, six states charge an inheritance tax. Iowa taxes inheritances this year but will stop at the end of the year. The other states are Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania.New Jersey has the highest inheritance tax, the TaxFoundation says. Other states have inheritance tax rates that start as low as 11 percent and go up to 16 percent. Although Nebraska’s inheritance tax goes higher—to 18 percent—it starts as low as 1 percent. Maryland has a flat inheritance tax of 10 percent.
If the deceased lived in a state with no inheritance tax, Investopedia says, then the beneficiary will not have to pay taxes. This rule also applies to those living in a state with an inheritance tax. Taxes depend on the state where the deceased lived.
If an heir lives in a state with an inheritance tax and there is a considerable amount of wealth to be transferred, TurboTax suggests that the heir might consider moving to a state without an inheritance tax. The move must be made before receiving the inheritance.
Paying the Inheritance Tax
Not everyone who receives an inheritance will have to pay an inheritance tax. Although it may vary with the state you live in, most states exempt the tax when a surviving spouse, parents, children, or siblings are the heirs.NerdWallet reveals that some states also permit a domestic partner, grandparents, grandchildren, great-grandchildren, stepchildren, and adopted descendants to avoid paying the tax.The States That Charge an Estate Tax
Your inheritance may also be reduced further if the state you live in charges an estate tax. The District of Columbia and 12 states do this: Connecticut, Hawaii, Illinois, Maine, Maryland, Massachusetts, Minnesota, New York, Oregon, Rhode Island, Vermont, and Washington.Maryland is the only state that charges an inheritance and an estate tax. Two states have an estate tax as high as 20 percent: Washington and Hawaii. Maryland and Iowa have inheritance taxes that max out at 10 percent.
Inheritance taxes may also depend on your relation to the deceased. Generally, those closest to the deceased (spouse and children) will not pay an inheritance tax. Relatives farther away may pay a small percentage, and others will pay more.
Exemptions to an Inheritance Tax
States that charge an inheritance tax have a tax exemption, which varies depending on where you live. The exemption enables you to receive an inheritance up to a certain amount that would be tax-free. Anything above that exemption amount is taxable, usually on a graded scale.Giving Your Estate Away as Gifts
If you live in a state where taxes will reduce your beneficiaries’ inheritance, you can give money to your heirs to avoid it. SmartAsset says the federal government allows you to give gifts up to $18,000 in 2024 to as many people as you want without affecting your lifetime gift exclusion.Couples may also give gifts to whoever they want. The Internal Revenue Service says it enables them to double the amount, allowing them a combined gift of up to $36,000 to the same person in 2024.
The gift tax lifetime exemption allows you to give away up to $13.61 million in 2024. Gifts worth more than $18,000 need to be reported to the IRS, but you will not pay any taxes until you are over the $13.61 million exemption. Any estate taxes owed to the federal government will only be on assets valued more than the gifts you passed on to others.
Gifts are not limited to individuals but can also be given to organizations. They can be unlimited, and you will not have to file anything with the IRS if you gift a spouse who is a U.S. citizen, a dependent, a political organization, or a charity. You can also give tax-free gifts by paying for a medical bill or insurance directly for someone else and directly to an educational institution for someone else. The exception to this rule is that there is a limit to how much you can give to a foreign spouse per year—$185,000.
The Annual Gift Exclusion Reverts to 2018 Levels in 2026
You can ensure your beneficiaries will receive more by giving gifts, which will also reduce your estate. Although the lifetime exclusion amount for gifts is currently $13.61 million, it will drop to its 2018 level of $5 million plus inflation at the end of 2025.You can also reduce your estate by making charitable donations. When made to qualified organizations, you get a tax deduction.
Selling Inherited Property
Property received as an inheritance can be sold, but Finance.Yahoo says you must know the fair market value (FMV) before doing so. The FMV is calculated at the time of death of the owner. After you sell inherited property, any gain from the sale above the FMV gets reported to the IRS as capital gains on inherited property, and you will have to pay taxes on it.There are many ways to reduce or avoid inheritance tax. Each state is different. Talk to an estate planner or tax consultant to learn more about decreasing taxes for your heirs or if you have received an inheritance and need to know how to keep more of it in your pocket.
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