How Much is Inheritance Tax?
When a person dies and leaves their estate to loved ones, the inheritance isn’t always free for the heirs. They may be required to pay an inheritance tax on what they are given. This can cause a hardship for some beneficiaries, which is why it is helpful to be prepared. It can be to your advantage if you’re an heir to an estate to understand what the inheritance is and how much you may be required to pay.
How an Estate is Dispersed
An inheritance tax is imposed on the property that has been distributed to the heirs. Before this can occur, the estate must go through probate. This is a fairly simple process in theory, but it can be quite complicated when carried out.
The court will appoint an executor who is responsible for determining the value of the estate. They may need to hire an appraiser to determine the worth of certain assets. The executor will also pay any debts out of the estate before the heirs can receive their portions.
Delays in Probate
While probate can take between five months and a year, delays can cause it to take even longer. Beneficiaries may dispute the validity of the will, or the executor may not accept a creditor’s bill as valid. In cases like this, the court will make the decision, which can take another few months.
Distributing the Assets
Once all debts are paid and income taxes have been filed and paid, the executor will distribute any remaining assets to the heirs as directed by the will. If there was no will, they will follow state statutes on how the estate is to be dispersed.
Part of the process of distribution may include selling certain assets. For instance, the executor may sell a home and land to give the heirs the proceeds instead of the actual property. For other assets, the executor may need to transfer ownership. For example, the decedent may have given an antique car to their descendent. The executor would need to put the title into the heir’s name.
Taxes on an Estate
An inheritance tax is one of two taxes paid out on an estate when the decedent passes away. This doesn’t include federal or state income taxes, which would be required if the decedent was still living. The two taxes which fall under the broad category as “death taxes” include the inheritance tax and estate tax.
The Estate Tax
The estate tax is a federal tax paid from estates that meet the minimum dollar amount requirements. This tax comes out of the estate before it is divided up among the heirs. The federal estate tax is a percentage of the value of the estate. Most estates won’t have to pay the federal estate tax because it has a high exemption. If you are concerned about whether an estate qualifies for the federal estate tax, you can talk to an attorney.
The Inheritance Tax
The other tax on an estate is the inheritance tax. This tax is paid out after the inheritance is distributed among the heirs. Each heir is responsible for paying their portion of the inheritance tax based on how much they inherited.
Capital Gains Tax
While the capital gains tax isn’t technically an estate tax, it is an important tax to know about if you inherit property that you want to sell. This tax is based on the profit you make when you sell something.
An example is if you inherit the family home from a deceased parent. Perhaps you keep the home for a year or two to fix it up, maybe even rent it out. Now, you’re ready to sell it and it has increased in value during that time. You would pay taxes on the difference in value from when the decedent died and when you sell it. This is a tax you should be aware of because you’ll need to have the funds on hand or calculate the tax in your selling price.
Income Tax
The executor will need to file the final federal and state tax return for the estate and pay any taxes owed. If the deceased person owned a business, they would need to calculate the tax on any income from the business.
It is possible that you would have to pay all of these taxes on a single estate, including both a federal estate tax and a state estate tax.
Which States Impose the Inheritance Tax?
Only six states even use the inheritance tax.
- Pennsylvania
- Iowa
- New Jersey
- Nebraska
- Kentucky
- Maryland
Eleven states have the estate tax, and only Maryland includes both the estate tax and inheritance taxes.
Who Pays the Inheritance Tax
Not every heir must pay an inheritance tax even in these six states. Each state has its own statutes for who is required to pay the inheritance tax and how much. Spouses usually don’t have to pay the tax and most of the time, neither do adult children of the decedent. Some states allow for other relatives to inherit without paying a tax or paying less of a tax.
Heirs are usually broken down into three categories. First is the immediate family, which includes the spouse and children, parents, and grandparents. Second is the extended family, which would include siblings, and even aunts, uncles, and cousins. The third group is non-related heirs, which might include charitable organizations, friends, and even the decedent’s pets. Some states tax each of these groups at different rates.
How the Inheritance Tax is Calculated
Unlike the estate tax, which is a federal tax, the inheritance tax is determined by individual states. However, a state may impose an estate tax in addition to the federal estate tax. Most states don’t have an inheritance tax. In fact, only a few require the tax on inheritances. Each state determines how much an inheritance must be valued at to make the inheritance tax applicable.
Once an inheritance reaches the threshold to qualify for the inheritance tax, the amount to be paid is generally based on a percentage. The percentage varies by state and even by amount. Many times, it is a percentage up to a certain dollar amount, another percentage up to the next dollar amount, and so on.
Threshold for Inheritance Taxes
Not all estates located in the six states with inheritance tax laws must pay the tax. There is a threshold of value which differentiates which estates have the tax imposed. Any estates valued under this amount are exempt. The value of the estate is determined after the deceased person has passed away and the executor of the estate takes inventory. They must determine the value on all assets, which may include appraisals for certain assets, which will be used to determine the estate tax and inheritance taxes.
State Guidelines for Inheritance Taxes
Each of the six states has its own laws for inheritance taxes, which may change.
- Iowa – Extended family pays a 5 percent tax on the first $12,500 of the inheritance and up to 10 percent of estates worth over $150,000. Distant family and unrelated heirs pay between 10 and 15 percent of the value of the inheritance. Charitable and nonprofit organizations don’t pay a tax if the amount is less than $500 but 10 percent of anything over the amount. Other heirs pay 15 percent tax as a flat rate on all inheritance received.
- Kentucky – Extended family pays from 4 percent on inheritances valued at $10,000 up to 16 percent on those above $200,000 with eight margins in between. The first $1000 is exempt from the inheritance tax. Anyone other than family gets $500 with no tax. Anything over that is taxed between 6 and 16 percent.
- Maryland – Lineal and immediate family are exempt from the inheritance tax. Other heirs must pay a flat rate of 10 percent on all assets. The state also imposes an estate tax in addition to the inheritance tax.
- Nebraska – Only the spouse is exempt from the inheritance tax in this state. Others are grouped into categories. Immediate and lineal family don’t have to pay a tax on the first $40,000 received. Anything over that is taxed at one percent. Extended family pays a 13 percent tax over any inheritance over $15,000. Other beneficiaries pay a tax rate of 18 percent over $10,000.
- New Jersey – Direct family members are exempt from the tax, but siblings and in-laws must pay if the inheritance is more than $25,000. The tax rate starts at 11 percent with four changes up to 16 percent. The top rate is for any inheritance over $1.7 million. Unrelated heirs pay 15 percent on the inheritance up to $700,000 and 16 percent over that amount.
- Pennsylvania – This state charges a flat tax rate of 4.5 percent if you are the lineal family member of the deceased person. Only the spouse and minor children are exempt. Siblings and other relatives pay 12 percent while non-family heirs pay 15 percent.
Discounts for Paying the Tax Early
States may offer a discount if you pay the inheritance tax before it is due. For instance, you can save 5 percent if you pay within the first three months, but you have nine months to pay the tax.
Kentucky offers a five percent discount if the tax is paid within nine months. It must be paid within 18 months. These are the only two states to offer a discounted rate for inheritance taxes under current laws.
What If You Can’t Pay the Inheritance Tax
Each state has a specific deadline for when the tax is to be paid once you receive the inheritance. For Maryland and Pennsylvania, the tax must be paid within nine months while New Jersey is at eight months. Nebraska allows 12 months for payment and Kentucky is the most generous at 18 months.
Extensions
If you can’t pay the tax during this time, you may have the option of an extension. Maryland and Pennsylvania offer extensions with New Jersey providing a limited extension up to six months. A payment plan may be used in Kentucky. Nebraska is the only state that doesn’t allow for any extension or payment assistance.
Penalties
States may impose a penalty for not paying the inheritance tax, which would mean they would owe even more. Even beneficiaries who don’t need to pay the tax may need to file an inheritance form. It is a good idea to talk to an attorney if you receive an inheritance in one of these states.
What If the Heir Lives in Another State?
The inheritance tax is imposed on the heir based on where the decedent had property. It doesn’t matter if the heir lives in another state. They will pay the tax to the state where the property is located.
Get Help for Your Inheritance Tax
If you have received an inheritance or know you will be receiving one and live in one of the states that impose the state inheritance tax, you should seek the counsel of an estate attorney. They can help you understand estate or inheritance taxes and your obligation to pay the tax and fill out the proper forms as well as answer any questions you might have.
