Is Your Inheritance Subject to State Taxes?
What states have an inheritance tax and will you have to pay?
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.
It's 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 2019, but only six states have an inheritance tax.
There's No Inheritance Tax at the Federal Level
The federal government doesn't 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, 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 when you after possession of the bequest.
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 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 New Jersey did as well until its estate tax was repealed in 2018.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 just $50,000 if the state only imposes the tax on inheritances over $50,000.
Iowa doesn't impose an 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 a State Tax?
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 physically located there for you to be potentially subject to that state's inheritance tax.
The rules aren't dependent upon where you live, but rather on where the decedent lived or owned property.
Let's 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 that 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 that 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 2019, from closest relatives to non-exempt relatives and other unrelated individuals:
- Iowa: 0% to 15%
- Kentucky: 0% to 16%
- Maryland: 0% to 10%
- Nebraska: 1% to 18%
- New Jersey: 0% to 16%
- Pennsylvania: 0% to 15%
Nebraska imposes the highest rate, Maryland taxes at the lowest rate, and Nebraska hits even 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 come 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.
Note: State laws can change frequently and the following information might not reflect the most recent changes. Consult with an accountant or an attorney for current tax or legal advice. The information contained in this article is not tax or legal advice and it's not a substitute for tax or legal advice.