What Is an Inheritance Tax?

Senior couple talking to a financial advisor about inheritance tax their beneficiaries may have to pay.
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DEFINITION
An inheritance tax is a state tax that heirs and beneficiaries who receive property from a deceased person's estate sometimes have to pay. The tax is typically a percentage of the value of what they receive, based on their degree of kinship to the deceased.

An inheritance tax is a state tax that heirs and beneficiaries who receive property from a deceased person's estate sometimes have to pay. The federal government doesn't have an inheritance tax, but six states do. The tax is typically a percentage of the value of what they receive, based on their degree of kinship to the deceased.

Learn more about inheritance tax, how it differs from estate tax, and whether it's something you may be liable for down the road.

Although the federal government doesn't have an inheritance tax, it does have a gift tax payable on some gifts made during the donor's lifetime.

Definition and Example of Inheritance Tax

An inheritance tax is assessed on individual bequests, not an entire estate, by the state in which the decedent lived or where they owned property. Some people make provisions in their estate plans or wills that their estate should pick up the tab on behalf of the beneficiary.

Tax rates are typically graduated, with spouses being exempt and more distant relatives and non-relatives paying the highest percentage. Some states exempt direct descendants as well.

  • Alternate name: Death tax

If your father lives in New Jersey and leaves you money in his will, you may have to pay inheritance tax to the state of New Jersey, regardless of where you reside, when you receive the money. You would not pay this tax to the federal government.

How an Inheritance Tax Works

Maryland, New Jersey, Pennsylvania, Kentucky, Iowa, and Nebraska have inheritance taxes as of 2022. Indiana had one but the state repealed it in 2013.

The inheritance tax rate usually graduates, depending upon the degree of kinship between the deceased and their beneficiary. Children of the deceased typically pay the lowest rate in states that don't exempt them. Charitable organizations that inherit are usually exempt.

Some states, like New Jersey, group beneficiaries into classes that determine the inheritance tax rate they'll have to pay. For example, siblings fall into "Class C" in New Jersey.

Small inheritances can often avoid the tax, because taxation doesn't kick in until the gift's value exceeds a certain exemption threshold. For example, New Jersey's inheritance tax ranges from 0% to 16%, but the 16% rate applies only to bequests valued at $700,000 or more for Class D beneficiaries, and to bequests valued at $2 million for Class C beneficiaries.

If your father, who lived in New Jersey, left you $25,000, you would not owe tax on the money. If he left you $500,000, the first $25,000 would be tax-free, and you would pay 11% tax on $475,000 of your inheritance. The amount of the inheritance tax you would pay to the state of New Jersey would be $52,250.

Inheritance Tax vs. Estate Tax

An inheritance tax isn't the same as an estate tax, although both are commonly referred to as "death taxes." An estate tax is imposed on the entire estate by a state taxing authority or the federal government. It's based on the right of the decedent to transfer assets after death, and on the overall value of the deceased person's entire estate. An inheritance tax is applied only to the value of a specific gift.

Twelve states and the District of Columbia have estate taxes as of 2022. Only Maryland has both an inheritance tax and an estate tax.

An estate is liable for paying the estate tax, while the beneficiary is responsible for paying the inheritance tax.

Tennessee imposed a state death tax that was based on the overall value of the deceased person's total property, which is technically an estate tax. The state referred to this tax as an inheritance tax in its statutes, and the tax was ultimately eliminated in 2016. 

Oregon used to call its state estate tax an inheritance tax as well, but that changed on January 1, 2012. The tax rightfully became known as what it is, an estate tax.

Inheritance Tax Estate Tax
Payable by the beneficiary Payable by the estate
Based on the value of a single bequest Based on the value of an entire estate
Rates graduate based on the beneficiary's familial relationship with the deceased A single rate typically applied to the portion of the value of an estate that exceeds an exemption amount

Do I Need to Pay an Inheritance Tax?

You wouldn't have to pay an inheritance tax even if you live in a state that has one, if the decedent didn't live and die there as well. An exception to this rule exists if you inherit real property that's located there, however. The tax is applied by the decedent's state of residence and the property's location.

For example, you would not have to pay New Jersey inheritance tax if you live there but your father, who lived in New York, left you $500,000 in his will. Still, your father's estate could be subject to other state or federal taxes.

You would not be responsible for inheritance tax unless the person who left you the money lived in one of the six states subject to the tax, and the amount of your inheritance met the threshold for the tax.

Key Takeaways

  • As of 2022, an inheritance tax is imposed by six states on the value of a single bequest made to a beneficiary.
  • The federal government does not tax inheritances.
  • The beneficiary, not the estate, is responsible for paying the inheritance tax, but some estate plans provide for the estate to pay the tax for it.
  • Speak with a local accountant or estate planning attorney if you think you might be subject to an inheritance tax because the rules can vary somewhat by jurisdiction.

NOTE: The information contained in this article is not tax or legal advice and is not a substitute for such advice. State and federal laws change frequently, and this information might not reflect your own state’s laws or the most recent changes to the law. Please see a local tax professional or attorney for current laws and rules in your area.

Article Sources

  1. Indiana Department of Revenue. "Inheritance Tax Information." Accessed Feb. 5, 2022.

  2. Pennsylvania Department of Revenue. "Inheritance Tax." Accessed Feb. 5, 2022.

  3. New Jersey Division of Taxation. "Inheritance Tax Beneficiary Classes." Accessed Feb. 5, 2022.

  4. State of New Jersey Inheritance and Estate Tax Branch. "Estate Tax Rates." Accessed Feb. 5, 2022.

  5. Protective Life Corporation. "Inheritance Tax vs. Estate Tax." Accessed Feb. 5, 2022.

  6. American College of Trust and Estate Counsel. "State Death Tax Chart." Accessed Feb. 5, 2022.

  7. Tennessee Department of Revenue. "Inheritance Tax." Accessed Feb. 5, 2022.

  8. New Jersey Division of Taxation. "Inheritance and Estate Tax." Accessed Feb. 5, 2022.