Is Your Inheritance Subject to State Taxes?
Only Six States Tax Inheritances
An inheritance tax is one that's imposed on an heir when she receives 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.
It's not based on the overall value of the estate. That's an estate tax, and 12 states plus the District of Columbia have estate taxes as of 2019. Only six states have an inheritance tax.
There's No Inheritance Tax at the Federal Level
The federal government does not have an inheritance tax, and the Internal Revenue Service doesn't tax most inheritances as income, either. But there are some exceptions.
Certain retirement accounts, such as 401(k)s and IRAs, are taxed as income 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 when you take possession of the bequest. This is the case at the state level as well.
States With an Inheritance Tax
The U.S. states that collect an inheritance tax as of 2019 are Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. Each has its own laws dictating who is exempt from the inheritance tax, and who will have to pay it and how much.
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 New Jersey did as well until its estate tax was repealed in 2018.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 this exemption amount aren't subject to the tax. You might inherit $100,000, but if the state only imposes the tax on inheritances over $50,000, you would pay an inheritance tax on just $50,000.
Iowa doesn't impose any inheritance tax on beneficiaries of estates valued at $25,000 or less, and this threshold is $30,000 in Maryland.
Is Your Inheritance Subject to State Tax? An Example
The deceased person would have to have either have lived in a state with an inheritance tax, or your bequest—such as real estate—would have to be located there for you to be potentially subject to an inheritance tax. The rules aren't dependent upon where you live, but rather where the decedent lived or owned property.
As an example, you live in California 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 to this 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 has not collected an inheritance tax since 1982. Assuming that your inheritance isn't located in Kentucky, it would not be subject to that state's tax even though you live there.
What if your uncle was a California resident who owned property in Kentucky, where you live? You would then be subject to Kentucky's inheritance tax if 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 that he owned other property elsewhere.
How Are You Related to the Decedent?
None of the six states with an inheritance tax impose the tax on surviving spouses. New Jersey exempts domestic partners as well. Descendants—children and grandchildren—are not taxed, either, in four of the states. Nebraska and Pennsylvania are the exception.
So 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 rates are expected to break down like this in 2019, with the lowest percentage applying to the most closely related non-exempt relatives:
- Iowa: 5 percent to 15 percent
- Kentucky: 4 percent to 16 percent
- Maryland: 10 percent for all beneficiaries
- Nebraska: 1 percent to 18 percent
- New Jersey: 11 percent to 16 percent
- Pennsylvania: 4.5 percent to 15 percent
Now let's turn this around and say that you inherited from your father and he lived in Pennsylvania. Here, your inheritance will be subject to the Pennsylvania inheritance tax because this state does not exempt children from the 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 will most likely calculate the tax due on each individual bequest from the estate based on that state's tax rate for each beneficiary. If you inherit cash, he'll most likely subtract what you owe from the amount of your bequest and report it on the appropriate inheritance tax form. You'll receive a check for the balance.
Of course, this isn't as likely to happen with very small estates that don't require much effort from the executor, if such an estate is even large enough to be subject to an inheritance tax at all. And you'll have to come out of pocket if you inherit a tangible asset. Contact the appropriate state's taxing authority for guidance.
The Bottom Line
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 the property there, and the heir is in a class that isn't exempt from paying the tax. The state where you live is irrelevant.
Note: State laws change frequently and the following information may not reflect recent changes in the laws. For current tax or legal advice, consult with an accountant or an attorney. The information contained in this article is not tax or legal advice and is not a substitute for tax or legal advice.