Inheritance Tax: What You Need to Know

Inheritance, an age-old practice of passing down assets or properties from one generation or individual to another, is subject to taxation in certain circumstances. This article delves into the ins and outs of inheritance tax, its difference from estate tax, and the ways to safeguard your inheritance from taxation.

Is Inheritance Taxable?

Typically, your inheritance could be subject to tax. However, the amount you’ll need to pay and whether you’ll have to pay at all depends on several factors, including the state in which the benefactor resided and your relationship with them.

Inheritance can face two forms of taxation – inheritance tax and estate tax. As the inheritor, you’re liable for the inheritance tax while the estate tax is deducted from the estate before division and distribution.

However, it’s worth noting that the federal government doesn’t impose an inheritance tax. It’s a state-level tax, and only six states – Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania – still enforce it.

Moreover, inheritance might also attract state and federal income taxes. Although inheritance isn’t typically considered income, certain types of inherited assets might have tax implications.

Inheritance Taxes Versus Estate Taxes

While these terms are often used interchangeably, inheritance tax and estate tax are two distinct forms of taxation. The primary difference lies in who pays the tax. Estate tax is deducted from the deceased’s assets before distribution to beneficiaries, while inheritance tax is levied after the inheritance is passed on to the heirs.

Another key distinction is that while inheritance tax is imposed only by states, both federal and state governments may collect an estate tax.

How Does Inheritance Tax Work?

Inheritance tax applies only if the deceased resided in one of the six states that levy it. If you, as the beneficiary, live in a state with inheritance tax, but the benefactor did not, you’re exempt from this tax.

Inheritance tax is levied only after the estate has been distributed to the rightful beneficiaries. Each beneficiary might owe a different amount, which depends on the value of the inheritance received, the beneficiary’s relationship with the deceased, and the state where the benefactor resided.

Inheritance Tax Exemptions

Inheritance tax rates vary depending on the beneficiary’s relationship with the deceased. All six states exempt surviving spouses from inheritance tax. New Jersey also provides a complete exemption for domestic partners, and all states except Pennsylvania and Nebraska exempt children and grandchildren.

Certain monetary exemptions are also in place. For instance, Iowa doesn’t tax inheritance if the net estate is worth $25,000 or less, and Maryland exempts estates with a total probate property value less than $50,000.

Inheritance Tax Rates

The rate of inheritance tax varies widely, depending on your relationship with the deceased. It can range from 0% to 18% of the value of the inheritance. The tax rate for each of the six states that collect inheritance tax varies from year to year.

Protecting Inheritance From Taxes

One viable way to protect your inheritance from taxation is by having the benefactor transfer their assets or put them into a trust. Benefactors can also consider gifting a portion of the inheritance each year instead of waiting until after their demise. Setting up a trust can safeguard your inheritance from taxation. Working with an accountant or financial advisor to manage tax strategies can also be helpful.

Tips for Wise Inheritance Spending

• Find a financial advisor to help you create an estate plan.
• Think before spending. Consider putting your money into a savings account or a money market account while you decide how to use it.
• Assess your current situation before making any moves. If you owe a lot of debt, use your inheritance to pay that off. If you’re behind on retirement savings, add the funds to your retirement savings account.

Conclusion

Remember, estate tax and inheritance tax are not the same. Inheritance tax is paid by the beneficiary after receiving their portion of the assets, and only six states currently impose it. The rate of inheritance tax varies depending on your relationship with the deceased. Always double-check state tax laws as they are subject to change.

Questions About Inheritance? Speak With A Diversified Advisor