Inheriting assets from family members or relatives may lead to the need to pay inheritance tax. This type of tax is only levied in certain states, but as an heir, there may be ways to avoid paying inheritance tax. The federal government does not impose inheritance tax on estate beneficiaries.
Before distributing assets to heirs, the executor of a will may need to pay inheritance tax. The federal government collects estate tax from the inheritor, and some states also have this tax. These taxes are paid from the estate before distributing money or assets to the heirs.
Currently, there are six states that impose inheritance tax on beneficiaries. Iowa levies this tax this year but will stop by the end of the year. The other five states that levy inheritance tax on heirs are Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. According to the Tax Foundation, a think tank, New Jersey has the highest inheritance tax. Although Nebraska also has a relatively high inheritance tax (up to 18%), the starting rate is only 1%. In other states, inheritance tax rates start at 11% and can go up to 16%. Maryland has a 10% inheritance tax.
According to the financial platform Investopedia, if the inheritor resides in a state that does not levy inheritance tax on beneficiaries, then the heir does not need to pay tax. Even if the inheritor lives in a state that imposes inheritance tax, they do not have to pay tax since the obligation depends on the state where the deceased lived.
If the heir resides in a state that imposes inheritance tax on beneficiaries, has a large inherited wealth, and needs to transfer this wealth to their own state, TurboTax recommends that the inheritor moves to a state that does not impose inheritance tax. However, the relocation must be completed before inheriting the estate.
Not everyone who inherits assets is required to pay inheritance tax. Although this may vary by state, most states exempt spouses, parents, children, or siblings from this tax. NerdWallet notes that some states also allow exemptions for domestic partners, grandparents, grandchildren, great-grandchildren, stepchildren, and adopted descendants.
If you reside in a state that levies inheritance tax on beneficiaries, your estate may be further reduced. The District of Columbia and 12 states impose inheritance tax on beneficiaries, namely Connecticut, Hawaii, Illinois, Maine, Maryland, Massachusetts, Minnesota, New York, Oregon, Rhode Island, Vermont, and Washington. Maryland is the only state that both taxes the benefactor and beneficiary. In Washington and Hawaii, the inheritance tax levied on beneficiaries can go up to 20%. Maryland and Iowa impose a maximum 10% inheritance tax on beneficiaries.
The inheritance tax also depends on the relationship between you and the beneficiary. Generally, closer heirs such as spouses and children are exempt from inheritance tax. More distant relatives may have to pay a smaller percentage of tax, while those who are even more distantly related will owe more tax.
States that levy inheritance tax often have exemptions based on where you reside. Inherited estates up to a certain amount may be exempt from the tax. The portion exceeding the exemption limit is taxable, usually taxed in graduated levels.
If you live in a state where inheriting will reduce the inheritor’s amount, you can gift money to the heir to avoid inheritance tax. SmartAsset states that the federal government allows you to gift up to $18,000 in 2024 to as many people as you wish without affecting your lifetime gift tax exclusion. Married couples can gift to any individual. The IRS allows couples to double the amount, permitting them to gift up to $36,000 to one person in 2024.
The lifetime gift tax exclusion allows you to gift up to $13.61 million in 2024. Gifts valued over $18,000 must be reported to the IRS but are not subject to tax until exceeding the $13.61 million exemption. The federal government only taxes assets beyond gifts given to others.
Gifts are not limited to individuals but can also be given to organizations or institutions. They can be unlimited if you gift to a spouse (who is a U.S. citizen), dependent, political organization, or charity without IRS reporting. You can also provide tax-free gifts by directly paying someone’s medical bills, insurance, or tuition fees for educational institutions. An exception to this rule is a restriction on the amount gifted to a foreign spouse annually, capped at $185,000.
By gifting, your heirs can receive more property while reducing your total estate. Although the current lifetime gift tax exclusion is $13.61 million, it is set to revert to the 2018 level of $5 million plus adjustments for inflation by the end of 2025.
You can also reduce your total estate by making charitable donations. Donating to qualified organizations can result in tax deductions.
Inherited property can be sold, but according to Finance.Yahoo, you must know its Fair Market Value (FMV) before sale. FMV is calculated at the time of the inheritor’s death. After selling inherited property, any profits exceeding FMV must be reported to the IRS as capital gains from the inherited property and taxed accordingly.
There are various ways to reduce or avoid paying inheritance tax, and regulations vary by state. Consult an estate planner or tax advisor to learn more about reducing taxes, or if you have inherited assets, understand how to preserve more of your wealth.