Aunt Edna always said you were her favorite (though she said that to all of her nieces and nephews). And when she died, she left you $10,000 and her collection of Precious Moments figurines. You’d give it all up just to spend an hour chatting with her at her kitchen table.
Losing a loved one is tough, and an inheritance is little comfort when it comes to grief. But to top it all off, you might have to pay an inheritance tax.
Whether you’ve received an inheritance, or you’re considering leaving an inheritance and wondering how taxes could affect it, we’ll walk you through how it works.
Let’s start with the basics.
What Is an Inheritance Tax?
An inheritance tax is a state tax you have to pay on property or money you receive from someone who has passed away. Don’t confuse the inheritance tax with the federal estate tax, which is tacked on estates worth more than $11.7 milllion.1 We’ll talk about estate taxes a little later.
Taxes shouldn’t be this complicated. Connect with a RamseyTrusted tax advisor.
Once upon a time, all 50 states had an inheritance tax, but over the years more states have done away with it. (Can we get an amen?) These days, only six states still have the tax: Iowa, Kentucky, Maryland, Nebraska, New Jersey and Pennsylvania.
When thinking about the inheritance tax, there are three big considerations. Who is the inheritance coming from (parent, grandparent, cousin, uncle, etc.)? What is the amount? And what state do you and the deceased loved one live in?
Who Pays the Inheritance Tax?
Let’s just get the not-so-good news out of the way. If your loved one lived in one of the six states mentioned above, you might be on the hook for the inheritance tax. We say might because spouses, parents and children are exempt from paying inheritance taxes in Iowa, Kentucky, Maryland and New Jersey.2 In Nebraska, only spouses are fully exempt; Pennsylvania exempts spouses and minor children.3
Cousins, nieces and nephews and other extended family members often have to pay the inheritance tax. Again, each state is different.
On the other hand, if your loved one lived in any of the other 44 states without inheritance taxes, you can, in most cases, collect your inheritance tax-free—even if you live in one of the six states with the tax. (This should be music to your ears!)
How Do Inheritance Taxes Work?
Now for some good news. Uncle Sam doesn’t have an inheritance tax and inheritances are not considered taxable income in most cases—so you won't have to report your inheritance on your state or federal income tax return.
For example, if your father-in-law from Tennessee, a no-inheritance-tax state, leaves you $50,000, and you live in, say, New Jersey— a state with an inheritance tax exemption threshold of $25,000 for children-in-law —that wouldn’t be considered income, and you would be free to enjoy the inheritance without worrying about taxes.4
On the other hand, let’s say your father-in-law lived in New Jersey, and he left you $50,000. You would pay an inheritance tax of 11% on $25,000 ($50,000 - $25,000) when it passes to you.5
Each state is different and taxes can change at the drop of a hat, so it’s a good idea to check tax laws in your state, or better yet, talk to a tax pro!
Inheritance Tax by State
Tax rates and laws vary depending on the state, and rates are generally based on how closely related the person inheriting the assets is to the deceased. The more distantly related you are and the higher the inheritance amount, the higher the tax rate goes up.
There isn’t a one-tax-rate-fits-all approach within the six states. Most of them use a progressive scale, which basically means the larger the inheritance, the higher the tax rate.
To stick with New Jersey as an example, remember that the tax exemption amount for children-in-law is $25,000. So anything under that you wouldn’t pay an inheritance tax. But anything over that amount up to $1.075 million will get hit with an 11% tax.8
And here’s some good news if you live in Iowa: The state voted to gradually phase out the inheritance tax until it’s gone by 2025.
Keep in mind that tax rates can, and do, fluctuate depending on the state. We recommend you connect with a tax Endorsed Local Provider (ELP). They are RamseyTrusted and can help you cover all your bases. When in doubt, reach out!
Inheritance Tax Rates by State
- Iowa: 4–12%9
- Kentucky: 4–16%10
- Maryland: 10%11
- Nebraska: 1–18%12
- New Jersey: 11–16%13
- Pennsylvania: 4.5–15%14
What About Retirement Accounts and Real Estate?
One important note: Some inheritances on retirement accounts (like a 401(k) or a traditional IRA) are subject to other pesky taxes, like income taxes. Retirement accounts like these can get sticky, and distributions (the amount of money you take out of a retirement account) are typically taxable. We know, it’s a lot, but hang in there.
Similarly, if you inherit a piece of property and sell it, you may have to pay a capital gains tax. That just means you’re taxed on any profit you make above the value of the property at the time of your loved one’s death and when you inherited it.
Both of these situations can get really confusing really fast, so you should get with a tax pro to make sure you’re covering all your bases.
What’s the Difference Between Inheritance Tax and Estate Tax?
It’s easy to get the inheritance tax and estate tax mixed up since those terms are often used interchangeably. But they are, in fact, two different types of taxes. The best way to differentiate between them is to remember who is responsible for footing the bill.
It’s pretty simple: The estate is responsible for paying the estate tax while the person inheriting is responsible for paying the inheritance tax.
Estate taxes are collected from the estate before any of the assets are given out. The federal estate tax is only assessed on estates worth more than $11.7 million for individuals and $23.4 million for married couples.15,16 That’s such a big threshold that very few of us will ever have to deal with the federal estate tax, but if you do inherit a multimillion dollar estate, taxes range from 18% up to 40%.17
That said, 12 states and the District of Columbia have estate taxes with much lower exemption thresholds than the federal limit. The states are: Connecticut, Hawaii, Illinois, Maine, Massachusetts, Maryland, New York, Oregon, Minnesota, Rhode Island, Vermont and Washington.18 Oregon and Massachusetts assess taxes when the estate is over $1 million, but the average threshold among the states is about $4 million. Tax rates can range from 0.8% up to 20%.19
The estate will pay any taxes and debts it owes before any inherited assets are handed out. Since estate taxes are collected before the inheritance is passed down, you won’t have to worry about it. Cue the sigh of relief!
The inheritance tax, on the other hand, is based on the value of the assets you inherit from someone’s estate. This means that you—the person inheriting—would be responsible for paying up if you aren’t exempt.
Inheritance Tax Exemptions
Let's talk exemptions—aka how you might be able to avoid having to pay the inheritance tax.
If one spouse dies, the surviving spouse doesn’t have to pay the inheritance tax in any of the states that collect it.
The inheritance tax also doesn’t apply if your loved one gave you money before they died. Receiving a gift not only benefits you, but also reduces the value of your loved one’s estate (remember, the estate tax is collected based on the value of the estate). Most states (with the exception of Connecticut) don’t tax gifts, but the federal tax threshold for gifts is $15,000 per person per year.20,21 So, if it’s under that threshold, your gift is tax-free. (What a wonderful phrase!)
Find a Tax Pro Near You
Just as you wouldn’t go through the grieving process alone, you don’t need to figure out this whole inheritance thing alone, either—especially if you’re considering investing it (which is a great idea, if you’ve already paid off all your debt!) or you just feel lost about how taxes come into play.
When you’re ready to talk to a tax pro, we’ll connect you with one of our Endorsed Local Providers (ELPs). They are RamseyTrusted and can walk you through your options and help make investing feel like a walk in the park. (Your future self will thank you.)
If your taxes are pretty straightforward and you want an easy-to-use tax software that can give you some peace of mind, check out Ramsey SmartTax. No hidden fees, no advertisements, no games. That’s how it should be!