The Inheritance Tax is a tax imposed on an inheritance received from the settlement of an estate upon the death of an individual. The recipient of the inheritance is responsible to pay the inheritance tax. It is different from the Estate Tax which is paid out by the estate at the death of an individual. For obvious reasons, the term Death Taxes refers to the combined Inheritance Tax and Estate Tax.
An Inheritance Tax is paid to the state whereas the Estate Tax is paid to the federal government. As of 2020, only six states collect an inheritance tax. Of the six states that impose an inheritance tax, Nebraska’s is highest at up to 18% of the inheritance and Maryland has the lowest tax at 10%.
Who Pays the Inheritance Tax and When Is It Paid?
The beneficiary of all or a portion of an estate settlement is responsible for the inheritance tax on the amount received from the estate of an individual. Since an inheritance tax is paid only to specific states, you will need to know the requirements in your state. States that collect an inheritance tax in 2020 are Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. All six of those states exempt spouses from inheritance tax liability. Some of the states allow other immediate family members exemption.
If the benefactor died in a state that does not collect inheritance tax and you live in one that does, it is possible that you may not have to payout. If the benefactor dies in a state that does collect an inheritance tax and you do not, you may still be liable. A tax specialist is your best source of information.
The inheritance tax is due within six months of the death of the benefactor. In some states, you may receive a discount for early payment. If you are late, as with other tax issues you can expect penalties and interest to be imposed.
Is the Inheritance Tax Collected by the Federal or State Government?
It is the state government that collects an inheritance tax from individual beneficiaries of an estate. The federal government imposes an Estate Tax on the estate of the deceased. This must be settled before the distribution of the estate and will impact the ultimate value of the estate.
From the perspective of the federal government, an inheritance is not considered taxable income. You may, however, incur a Capital Gains tax liability depending on whether the inheritance generates income, or you receive an investment that later sells for a greater value than when it was received. You will be liable for income earned on those properties and for accounts that increase in value while you own them.
How Does an Inheritance Create Capital Gains?
Be mindful of Capital Gains tax liability. While you may not owe inheritance tax to the federal government, if you receive accounts and/or property that will generate income, you will most likely owe federal taxes on the income they provide.
For example, from a tax-exempt retirement account, you will need to claim as income on your annual return any disbursements you receive each year. You will also be required to pay taxes on that income. If you receive rental property that generates an income, the income will need to be claimed on your annual tax return and taxes paid.
If you have questions or concerns, it is always best to confer with a tax specialist for advice and answers. The professionals at Tax Crisis Institute are qualified and available to assist you.
How Much Is the Inheritance Tax?
The inheritance tax rate varies within and among the six states that collect it. See below for information regarding the rate at which your inheritance is taxed in your state. For more information, consult a tax professional.
- Iowa imposes an inheritance tax of 5% – 15%.
- Kentucky’s inheritance tax is 4% – 16%.
- Maryland has the lowest flat tax at 10%.
- Nebraska’s tax range is 1% – 18%.
- New Jersey will collect 5 – 18%.
- Pennsylvania comes in at 4.5% – 15%.
Spouses are exempt from the inheritance tax in all six states that collect it. Some of the six states exempt children and grandchildren from the tax. Check your state law or consult with a tax specialist for more complete information.
Are There Ways to Minimize the Inheritance Tax Liability?
There are ways you can reduce the inheritance tax liability of the beneficiaries of your estate.
- Life insurance policies naming individuals as beneficiaries are usually exempt whereas policies paid to the estate often are not.
- Consider gifts to your beneficiaries on an annual basis. Individuals may give gifts up to $15,000 in a year with no tax liability to the recipient. Couples owning joint property can give gifts of up to $30,000 to individuals each year. The gifts do not have to be cash. They can be in the form of stocks, bonds, property or other assets. To avoid tax liability for the recipients, be sure not to exceed the allowable amount.
- If your estate is substantial making the inheritance tax substantial, you could consider moving to a state that does not collect an inheritance tax.
If you are seeking ways to reduce the inheritance tax liability for your beneficiaries, consider talking with an estate planning professional. You could also talk with a tax specialist at Tax Crisis Institute for information on both the Inheritance Tax and Estate Tax.
Regardless of the size of your estate, it is to be expected that those you love should be able to retain the result of your labor. To protect that for them you should seek to be well informed regarding Death Taxes (Inheritance Tax and Estate Tax) liability. Whether an Estate Tax paid to the federal government on the value of your estate at the time of your death or an Inheritance Tax paid on the value of what is received by your designated beneficiary, you need to be able to keep it to a minimum. Tax Crisis Institute offers a free consultation with qualified professionals.
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