Inheritance taxes in the US are levied on the beneficiaries of a will or an inheritance. This is not to be confused with the estate tax, which is levied on the estate itself and not paid by the beneficiaries. Most of the estates that are transferred to the heirs are too small to be taxed at the federal level. Similarly,
most of the states don’t have an estate tax or an inheritance tax.
The US Inheritance tax is levied on items and money over a certain limit as with the estate tax. It’s imposed on states that merit assets from the estate of the deceased. The tax rate depends on the state of residence and the value of the inheritance, of course. There is also the matter of the relationship of the beneficiary to the deceased. For instance, if you’re a spouse of the deceased, then you pay no taxes on inheritance.
The inheritance tax isn’t levied at all on the federal level. Indeed, there are only a few states that even have a state inheritance tax. These are Kentucky, Maryland, New Jersey, Nebraska, Pennsylvania, and Iowa.
However, before we delve in to the limits and exemptions for different states, here are a few things to note:
- Life insurance that is payable to a beneficiary will not get taxed. However, life insurance that is payable to a deceased person is subject to an estate tax.
- Inheritance tax is applied to the sum which exceeds the exemption amount. The tax levied on the amount above the exemption is decided on a ‘sliding basis.’ This means that the rates begin in the single digits and rise to about 15% to 19%. The exemptions that you receive and the rate charged can both vary by the relationship to the deceased. This can even vary more than the value of the inheritance itself.
- Hence, the closer that you are to the decedent, the higher tax exemption and the lower the taxes will be. If the deceased is survived by a spouse, then they will be exempt from the inheritance tax completely. There are some states like New Jersey that go even further and apply this rule to domestic partners. And descendants don’t pay Inheritance tax in Nebraska and New Jersey.
Calculating the Value of the Property
The value of the inheritance property can be calculated in one of three ways. The first is to value it at market value on the day of the death of the decedent. This is the usual method of determining the value of the property for tax purposes. The alternate valuation is that the market value in the next six months after the decedent’s death is calculated. The third way is to use a special valuation. However, that is only applicable if the value is used for federal estate tax purposes. It can’t be applied to the inheritance tax.
The market value of the property can be determined through the price that it can be sold at on the date of death. This can be determined through experts. For obvious reasons, beneficiaries aren’t allowed to determine this value for themselves.
Tax Thresholds for Different States
Of the six states that have the Inheritance tax, there are different thresholds for each one. Some state residents are liable to pay them depending on several rules as mentioned above. Here is a rundown of the six states and their Inheritance tax laws.
The inheritance tax is levied on the property in the estate received by the beneficiary as well as the liabilities, deductions and debts that it includes. The gross estate also includes real estate and the physical personal property which is located in the state of Iowa. This also includes the property that the decedent had an interest before death. All intangible personal property that was domiciled in Iowa by the deceased is also included.
Intangible property here includes the real estate contracts, bank accounts, promissory notes, mortgages, accounts receivable, crop rent, stocks, bonds etc.
An audit is conducted by the tax department for the purpose of checking all the property included in the inheritance. These will include the values of the property, the liabilities and expenses as well as the taxes due on them. If the department finds that there is additional tax due, then they will prepare assessments which will bundle them together.
All penalties and interest accrued on the property will also be included. If there is a major disagreement regarding the final assessment, then there is an appeals process to challenge it.
Expenses and Liabilities
Any liabilities like debt or expenses are deducted from the inheritance. This way the shares of the estate are computed accurately. Only very few liabilities and debts are deducted though. These include the debts of the decedent when death occurs. These include mortgages and liens while securing a debt on Iowa property that is owned by the decedent.
Taxes that are accrued before death are also included in the liabilities section. Funeral expenses as well as the expenses incurred while administering property in the gross estate are also all deductible. Fiduciary fees and legal fees as well as fees that are incurred due to manual labor are all included in this. Some liabilities however, have to be prorated if they are associated with out-of-state property.
This is a list of exemptions on Iowa inheritance tax.
- There is no inheritance tax on property that passes to surviving spouses from the decedent prior to 7/1/97.
- After 7/1/97, any property passing to the surviving spouse is exempt from taxes. Any property that passes to parents, grandparents, great-grandparents, and other ascendants is also exempt. Property that passes to biological children and legally adopted children, step-children and grandchildren and great-grandchildren is exempt as well.
- For any deaths that occur after 7/1/2016, there is now an exemption for the descendents of stepchildren.
- All other beneficiaries don’t receive exemptions.
- If the inheritance is left to charitable organizations, then special tax rates apply to them.
- The first $500 total of all masses that is specified in the will is exempt from taxes.
- If the value of the property of the estate is under $25,000, then no tax is due.
- Annual gifts under $13,000 aren’t taxable.
- Any annuities purchased under employee pension plans or retirement plans already subject to federal income tax aren’t taxable.
Three types of beneficiaries in Kentucky are exempt from inheritance taxes depending on their relationship with the deceased.
Class A: These include the deceased’s spouses, parents, siblings, children and grandchildren (biological and adopted), step-children and step-grandchildren. These also include some charitable organizations. Class A beneficiaries are all totally exempt from paying the Kentucky state inheritance tax.
Class B: These include nieces and nephews, half-nieces and half-nephews, as well as daughters and sons-in-law. Aunts, uncles, great-grandchildren (biological, adopted, or by stepchild) are also included. Class B beneficiaries are eligible for an exemption of $1000 in taxes each.
Class B Beneficiaries are subject to taxes ranging from 4-16%.
Class C: These beneficiaries include anyone that is not listed in Class A or B. Class C beneficiaries are eligible for an exemption of $500 each.
Class C Beneficiaries are subject to taxes ranging from 6-16%.
Life insurance payable to the decedent or the estate of the decedent is included in the value of the inheritance.
Funeral expenses which don’t exceed $5000 are deductible from the inheritance tax. Any expenses which are accrued during administration, execution, commission, etc, including legal fees and court costs are deductible.
Any debts including taxes on the property that were a lien against the property on the date of death, are deductible.
Federal estate tax is deductible on the proportion that the net estate in Kentucky subject to the tax bears.
- Inheritance taxes in Maryland don’t apply to spouses, children (biological, adopted, stepchildren, grandchildren, etc), or parents and grandparents. Siblings are also exempt from this tax. Laws also exempt children, grandchildren, and lineal descendants of spouses from the tax.
- Surviving spouses of deceased children, if they haven’t remarried, are exempt from the tax.
- Any businesses like partnerships and LLCs or corporations are exempt from the tax if all its owners are exempt.
- Nonprofit organizations from Maryland also have tax exempt status under section 501 (c)(3) of the Internal Revenue Code. Other nonprofits may also be exempt depending on the laws of the states where they’re organized.
- No taxes are levied on the proceeds of life insurance policies.
- No taxes are imposed on inheritances of less than $1000.
- No taxes are levied on amounts that are given as compensation for Holocaust-related losses.
- The primary residence of the deceased person is exempt from the inheritance tax. This is provided that the residence was owned by the deceased and their domestic partner and they were joint tenants.
- All inheritances under $30,000 are exempt from taxes.
The inheritance tax in Maryland is 10%. The value on which the tax is levied is defined as the ‘clear value’ of the inherited property. Clear value here means the fair market value of the property.
Any surviving spouses and charities are exempt from the inheritance tax.
Parents and grandparents, siblings and children (biological and adopted), and lineal descendants are all immediate relatives. Also, anyone who was acknowledged as a parent or spouse or surviving spouse of such a person is also an immediate relative. They all receive an exemption of $40,000 on the inheritance tax.
Remote relatives include uncles and aunts, nieces and nephews (biological and adopted) and the spouses or surviving spouses of mentioned. Every remote relative receives an exemption of $15,000 in the inheritance tax.
All other transferees unlisted above receive an exemption of $10,000.
Any life insurance which is payable to the estate of the deceased is included in the value of the estate. However, any life insurance that is payable to a beneficiary that is living isn’t subject to taxation.
These are the deductibles from the Nebraska estate.
- Funeral expenses which include internment and gravesite marker costs.
- Any administrative expenses which include legal fees and court costs as well as expenses that concern property.
- Expenses which were incurred because of the last illness suffered by the deceased within six months of death.
- Debts that have been paid after the death of the decedent.
- Federal estate taxes that have been paid, are payable or expected to become payable. All applicable credits, once deducted, which is attributed to the Nebraska inheritance tax laws.
All immediate relatives have to pay an inheritance tax of 1%. Remote relatives have to pay inheritance taxes of 13%. And all other transferees have to pay an inheritance tax of 18%.
Most charitable organizations are exempt right off the bat. Bequests that are valued at less than $500 are not taxed. Life insurance proceeds which are gifted through a will or trust aren’t taxed either.
Hence, any payments which are made posthumously from the state’s public retirement system, the teacher’s pension, etc, are all exempt. The same goes for the New Jersey Police and Firemen’s Retirement System. Annuities paid to beneficiaries by the federal government under the Retired Serviceman’s Family Protection Plan are also exempt.
Immediate family members are classified within Class A and they are completely exempt from the inheritance tax. They include spouses, grandparents, parents, children grandchildren, and great-grandchildren. Civil union partners and domestic partners are also classified as Class A.
Beneficiaries Subject to Tax
All other classes of beneficiaries aren’t exempt from the tax. They pay a graduated tax rate. These are all Class C beneficiaries. They include siblings, spouses, widows, widowers, children, and surviving civil union partners of the children.
They can receive up to $25,000 in inheritance without being taxed. Any values exceeding that amount are taxed from 11 to 16%. Inheritances valued at $1.7 million or above are subject to the 16% rate.
Class D beneficiaries include all others and they pay 15% on the first $700,000 received. Anything above that is taxed at 16%.
All the following people are exempt from the inheritance tax.
- If the estate of a child of aged 21 or younger is transferred to the natural parent, (biological, adopted or stepparent)
- Exempt charitable organizations, institutions and government entities also don’t pay the inheritance tax.
Then are the beneficiaries that pay taxes.
Class A: This includes parents, grandparents, natural, adopted, and step-descendants. Your children, their children and grandchildren are also included. Children that are adopted by someone else are still included in the category. Children’s spouses that have not remarried after the child’s death are also included.
All these relatives are entitled to a $3,500 exemption from the Pennsylvania inheritance tax.
Class A1: Siblings, half-siblings, step-siblings, by blood or by adoption are all classified as type A1. Class A1 beneficiaries don’t have a special exemption from the tax.
Class B: All other beneficiaries are included here. They receive no exemptions. Same-sex partners are also included in this list. Same-sex spouses however, are not since they’re included under spousal exemption.
As of June 30, 2000, the inheritance tax rate in Pennsylvania is 4.5%. That tax is to be paid by Class A beneficiaries. A 12% tax rate exists for siblings who are classified as Class A1 beneficiaries. Class B beneficiaries pay a collateral tax rate of 15%.
Lifetime gifts are also taxable in certain situations. For example, your entire estate may be passed to your son or daughter during your lifetime. If you die within that year, then any balance over $3000 will be taxed at 4.5%.
If you give your spouse your home and continue living in it until your death, then it becomes taxable inheritance.
While family farms and some agricultural commodities are exempt from the inheritance tax, there are many qualifiers. The first is that the exemption is only for deaths occurring after June 30, 2012.
The transfer of the farmland should only be between members of the same family. Hence, distant relatives like third cousins don’t count. He land has to be devoted to the business of agriculture only. It can’t be used for any other purpose for at least seven years beyond the death of the decedent. The farmland should also produce nearly $2,000 worth of income.
If even a piece of that farmland is found to be used for non-agricultural purposes within seven years, tax will be paid on it. Not only that, interest will also be paid on that tax.
Any transfer of agricultural commodities and conservation easement, reserve and use property is also tax exempt. Any transfer of forest land is also exempt. The exemption is only applicable on siblings and lineal descendants.
All the payments that are received from life insurance contracts are exempt from the inheritance tax. It doesn’t matter if they’re paid to the estate or to a beneficiary.
Mitigating Inheritance Taxes
Inheritance taxes can be minimized by estate planning. The federal tax code allows people to gift nearly $15,000 for every recipient without any federal gift taxes. Hence, the more property that you transfer in your lifetime, the less is transferred in death.
While most Americans aren’t affected by the Inheritance tax, it’s a good idea to know what you stand to gain.