Understanding Inheritance Taxes: What You Need to Know
When someone leaves you an inheritance, you might wonder if you’ll have to pay taxes on it. The good news is that there’s no federal inheritance tax, and only a handful of states have inheritance taxes.
Where You Live Doesn’t Matter
If the person who left you the inheritance lived in Kentucky, Maryland, Nebraska, New Jersey, or Pennsylvania, you might need to pay an inheritance tax to that state, even if you don’t live there. The tax is triggered by where the deceased person lived and the date of death, not where you reside.
How Inheritance Taxes Work
An inheritance tax is a state tax paid by the person who inherits money or assets. The amount of the tax and the threshold for having to pay depend on the amount of the inheritance. Rates are progressive, meaning the more assets you inherit, the higher the rate. The tax is based on the fair market value of the assets.
Estate Taxes vs. Inheritance Taxes
While both are types of death taxes, estate taxes and inheritance taxes are not the same thing. Estate taxes are levied on the estate of the deceased, reducing its overall value, while inheritance taxes are paid by the beneficiary.
Who Pays Inheritance Taxes?
If the decedent lived in one of the five states with an inheritance tax, you might face a tax bill, even if you don’t live there. However, the closer your relationship to the deceased, the less likely you are to face tax liability. Surviving spouses, parents, children, and grandchildren are often exempt from paying inheritance taxes, while siblings, nieces, or nephews might need to pay.
State-by-State Breakdown
Here’s a breakdown of the states with an inheritance tax, who is exempt from paying, who is partially exempt, and the point where the tax kicks in:
- Kentucky: Exempts spouses, parents, children, and grandchildren; tax kicks in at $1,000
- Maryland: Exempts spouses; tax kicks in at $1,000
- Nebraska: Exempts spouses, parents, children, and grandchildren; tax kicks in at $10,000
- New Jersey: Exempts spouses, parents, children, and grandchildren; tax kicks in at $25,000
- Pennsylvania: Exempts spouses; tax kicks in at $3,500
Planning Ahead
If you live in a state with an inheritance tax, you might be able to gift some assets while you’re still alive or buy a life insurance policy with the beneficiary receiving a death benefit, which is not taxable. Talking to an estate planning professional can help you navigate these options.
Tax Implications of Inherited Property
If you inherit property and sell it at a profit, you might have to pay taxes on the gain. However, if you hold onto the property, there’s no tax. The amount you pay depends on the property’s fair market value when the person who gave it to you died.
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