What you pass along to the next generation may be shrunk because of inheritance tax, and these taxes are applied differently around the world. Currently, six U.S. states impose an inheritance tax, and according to the Tax Foundation, the rates in these states can reach as high as 18%.
Even though the federal estate tax exemption sits very high at $13.61 million in 2024, family members may still find themselves surprised by their state’s thresholds. It matters who takes care of the bills, how much they cost, and how the money is spent, to ensure a family’s legacy is safe.
What Is Inheritance Tax
When someone dies, the heirs of their estate may have to pay inheritance tax on their inheritance. If estate tax is paid by the estate, inheritance tax is collected instead from the person who has received the inheritance. Certain states in the U.S. do not have income tax, and the rules regarding it, such as the rates and exemptions, vary by location.
Still, people often become confused; however, it’s essential to understand that inheritance tax affects the person receiving the assets, not the entire estate.
No Federal Inheritance Tax
The federal inheritance tax is not applied in the United States. Although estates are subject to federal taxes, inheritance taxes are collected solely by the states. In states without an inheritance tax, beneficiaries do not face those costs.
However, if the person you inherit from resides in a state that imposes inheritance taxes, you may still owe taxes on what you inherit, regardless of where you live.
States That Impose an Inheritance Tax
Currently, inheritance taxes are applicable in just six states. Along with Iowa, which will eliminate its inheritance tax by January 1, 2025, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania have also abolished this type of taxation.
If you receive money from someone in these states, make sure to check whether you need to pay taxes on it, no matter where you reside.
Who Pays the Tax
The inheritance tax must be managed by the new owner of the asset, rather than by the estate itself. When an individual passes away, their executor divides the estate assets among the beneficiaries, who may then be responsible for any taxes that arise.
Beneficiaries are required to pay inheritance taxes, meaning these taxes are not deducted from the estate before distribution.
Exemptions for Close Relatives
The rules regarding exemptions are a significant part of the inheritance tax. Everyone in the five inheritance tax states can inherit without any tax, and many offer exemptions or lower rates for immediate family members.
In Pennsylvania, children under 21 can shop tax-free, while in New Jersey, parents and grandparents are exempt from tax payments. Generally, a closer relationship to the deceased means you will pay more in taxes.
Variation in State Rates and Thresholds
Tax rates and exemption limits for inheritance tax vary across U.S. states. In Kentucky, tax rates range from 4% to 16%; in Nebraska, rates range from 1% to 15%; and in New Jersey, rates span from 11% to 16%.
Additionally, threshold exemptions differ: in Nebraska, you do not need to pay taxes on the first $100,000 given to close relatives, while in New Jersey, the threshold is $25,000. Understanding how much tax you will owe and when is crucial for making accurate plans.
Relationship Determines Tax Rate
Inheritance tax rates tend to be lower, or exemptions higher, if you are closer to the deceased. For instance, siblings, nieces, nephews, and unrelated individuals usually pay significantly more in taxes than children or spouses.
Understanding how inheritance taxes are assessed is essential to knowing what you owe after receiving property or other assets.
Exemptions and Allowances by State
Each state has its own laws concerning who is exempt from paying inheritance tax. The state does not collect inheritance tax from children, parents, or siblings, but charges a 10% tax on others.
In Pennsylvania, up to 15% must be paid on inheritances left to individuals not directly related to the deceased and up to 4.5% on direct descendants. Utilizing these state-specific exemptions can significantly reduce your liability.
Jointly Owned Property and Tax Implications
State laws can result in specific tax implications for joint ownership of property. Joint property with survivorship may not incur the full inheritance tax, but it could be taxed solely on the portion owned by the deceased.
Properly documenting and titling assets ensures that taxes are managed by the law.
Filing and Paying the Tax
Filing and paying inheritance tax is usually required a few months after the individual’s death. In the U.S., the filing period is typically nine months in most states.
Paying on time helps prevent penalties and allows probate to proceed without complications. Consulting a tax professional is recommended to ensure compliance with all regulations.
Tax Planning Strategies
Advance planning can help you reduce or avoid the taxes on your inheritance. You can transfer assets now, use trust funds, or designate charities as the beneficiaries for tax-free income.
Seeking assistance from a financial advisor before creating your estate plan can lower the taxes you may owe.
Residency Impacts Tax Liability
In essence, whether inheritance tax applies and its amount depend on the residence of the deceased and the location of the assets. Not having inheritance tax in your own state does not exempt you from owing taxes if you receive a gift from someone in another state.
Furthermore, assets located in other states may be subject to different regulations based on the tax laws in that state.
Life Insurance and Taxation
Proceeds from a life insurance policy are typically not subject to inheritance tax when paid to a named beneficiary. However, if the funds are designated for the estate, they may be subject to inheritance or estate tax.
Establishing named beneficiaries is the simplest way to avoid unnecessary taxes.
Charitable Beneficiaries and Tax Exemption
The inheritance tax generally does not apply to assets left to registered charities. Many states offer reduced taxes on estates that allocate a significant portion of their assets to charitable causes.
For tax purposes, consulting with a tax advisor can improve how your philanthropy is integrated into your will or trust.
Disclaimer – The Finance Key does not provide and does not intend to provide financial, investment, tax, or legal advice. Information contained in this article is for informational and educational purposes only. This list is solely the author’s opinion based on research and publicly available information. The inclusion of links to third-party content is not an endorsement by The Finance Key of such content or services. Please do your due diligence and use your discretion.
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How Total Beginners Are Building Wealth Fast in 2025
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