Is Your Inheritance Subject to State Taxes?

States That Have an Inheritance Tax and What You'll Have To Pay

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An inheritance tax is one that's imposed on heirs when they receive assets from a deceased person's estate. It's based on the relationship between the beneficiary and the decedent, as well as the value of that specific item of inherited property.

The inheritance tax is not based on the overall value of the estate; that's an estate tax. Although, both taxes are often lumped together as "death taxes." Twelve states and the District of Columbia have estate taxes as of 2022, but only six states have an inheritance tax (Maryland has both taxes).

Key Takeaways

  • Inheritance tax is imposed at the state level and not all states have one.
  • The rule applies to the state where the deceased lives, not where the beneficiary resides.
  • Spouses and sometimes children are exempted from the tax, while nieces, nephews and other relatives are not.
  • Executors of the estate are likely to pay any inheritance taxes owed by named beneficiaries.

Taxes at the Federal Level

The federal government doesn't have a specific inheritance tax. Instead, it has an estate tax. The estate tax is a tax on the right to transfer property at your death. All of your property is totaled at its fair market value to equal your gross estate. This may include cash, investments, real estate, insurance, trusts, annuities, business interests, and more.

However, most estates will not have to pay the estate tax and file an estate tax return. An estate tax return is only required if the gross estate—the combined gross assets and prior taxable gifts—exceeds $11.7 million in 2021 or $12.06 million in 2022.

Other inheritances may be taxed if they are required to be included with the heir or beneficiaries' taxable income.

Certain retirement accounts, such as 401(k)s and IRAs, are taxed as income, but only when withdrawals are made from the accounts by the beneficiary. And if you inherit property or assets that generate income or interest, that income or interest is typically taxable to you after you take possession of the bequest.

States With an Inheritance Tax

The U.S. states that collect an inheritance tax as of 2021 are Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. Each has its own laws dictating who is exempt from the tax, who will have to pay it, and how much they'll have to pay.

Maryland imposes both an estate tax and an inheritance tax. New Jersey did as well until its estate tax was repealed in 2018.

State rules usually include thresholds of value. Inheritances that fall below these exemption amounts aren't subject to the tax. You might inherit $100,000, but you would pay an inheritance tax on only $50,000 if the state only imposes the tax on inheritances over $50,000.

Iowa, for instance, doesn't impose an inheritance tax on beneficiaries of estates valued at $25,000 or less.

Is Your Inheritance Subject to a State Tax?

If the deceased person lived in a state with an inheritance tax, you could be subject to that state's tax. The other instance is if a bequest—such as real estate—is physically located there.

The rules don't depend on where you live, but rather where the decedent lived or owned property.

How the Inheritance Tax Works

Let's say you live in California—which does not have an inheritance tax—and you inherit from your uncle's estate. He lived in Kentucky at the time of his death. You would owe Kentucky a tax on your inheritance because Kentucky is one of the six states that collect a state inheritance tax.

The flip side is if you live in Kentucky and your uncle lived in California at the time of his death. Your inheritance would not be subject to taxation in this case because California hasn't collected an inheritance tax since 1982. Assuming your inheritance isn't physically located in Kentucky, it wouldn't be subject to that state's tax even though you live there.

You would be subject to Kentucky's inheritance tax if your uncle was a California resident who owned property in Kentucky, where you live, because your bequest is physically located there. But if you inherited an asset that was located in California, your inheritance would not be affected by the fact he owned other property elsewhere.

How Are You Related to the Decedent?

None of the six states with an inheritance tax impose it on surviving spouses. New Jersey exempts domestic partners as well, and Maryland has exempted jointly-held primary residences inherited from domestic partners since July 1, 2009.

Descendants—children and grandchildren—aren't taxed, either, in four of the six states that impose this tax. Nebraska and Pennsylvania are the exceptions. Your inheritance would be subject to the Pennsylvania inheritance tax if you inherited from your father and he lived there.

Your inheritance would not be subject to a Kentucky inheritance tax if you're the decedent's spouse, son, daughter, or grandchild. As the decedent's niece or nephew, however, you'd pay an inheritance tax, and if you were not related at all, you'd pay the highest inheritance tax rate.

State Tax Rates

The top state rates break down like this in 2021 and 2022, excluding those who are exempt from tax, such as spouses or, in some states, children or other close relatives. The rates shown are ranges for the various levels of non-exempt relatives with unrelated individuals taxed at the highest rate.

  • Iowa: 4% to 12%
  • Kentucky: 4% to 16%
  • Maryland: 10%
  • Nebraska: 1% to 18%
  • New Jersey: 11% to 16%
  • Pennsylvania: 4.5% to 15%

Nebraska imposes the highest rate and even hits close relatives with a 1% tax.

How the Tax Is Calculated and Paid

You might not have to deal with personally sending a check to the state taxing authority if your gift is subject to an inheritance tax.

The executor of the estate will most likely calculate the tax due on each individual bequest from the estate based on that state's applicable rate for each beneficiary, then subtract what you owe from the amount of your bequest. But this only works if you inherit cash. You'd receive a check for the balance.

You'll probably have to pay out of pocket if you inherit a tangible asset. Although, some decedents will leave instructions in their wills that the estate will pick up any inheritance tax that's owed by each beneficiary.

The Basic Rules

An heir's inheritance will be subject to a state inheritance tax only if two conditions are met: The deceased person lived in a state that collects a state inheritance tax or owned bequeathed property located there, and the heir is in a class that isn't exempt from paying the tax. The state where you live is irrelevant.

Frequently Asked Questions (FAQs)

Is an inheritance considered income for federal tax purposes?

Inheritance is generally not considered taxable income for federal tax purposes. However, anything earned on the inheritance—whether it's cash, property, or investments—can be considered taxable.

What's the difference between an inheritance tax and an estate tax?

An inheritance tax is levied at the state level and is paid by whomever receives the inheritance. An estate tax is paid from the estate. There are limits that must be reached before either the inheritance or estate tax kicks in.

Article Sources

  1. Tax Foundation. "Inheritance Tax."

  2. Urban Institute and Brookings Institution Tax Policy Center. "How Do State Estate and Inheritance Taxes Work?"

  3. Internal Revenue Service. "Estate Tax."

  4. Internal Revenue Service. "Instructions for Form 706," Page 2.

  5. Internal Revenue Service. "401(k) Plan Overview."

  6. Internal Revenue Service. "Topic No. 451 Individual Retirement Arrangements (IRAs)."

  7. Urban Institute. "Estate and Inheritance Taxes."

  8. Iowa Department of Revenue. "Introduction to Iowa Inheritance Tax."

  9. Kentucky Department of Revenue. "Inheritance & Estate Tax."

  10. Tax Foundation. "Does Your State Have an Estate or Inheritance Tax?"

  11. Comptroller of Maryland. "Filing the Estate Tax Return."

  12. New Jersey Treasury Division of Taxation. "The Domestic Partnership Act - New Jersey Income Tax/Inheritance Tax (2/18/04)."

  13. Nebraska Legislature. "Nebraska Revised Statute 77-2001."

  14. Policygenius. "State-by-State Guide to Inheritance Taxes."