Inheritance tax: here’s who pays and in which states

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An inheritance tax is a state tax that Americans pay when they inherit property from a deceased person. There is no federal inheritance tax and the amount you owe depends on your relationship with the descendant and where you live. In 2021, only six states levy inheritance tax, according to the Tax Foundation, and many beneficiaries are exempt.

Inheritance tax vs. inheritance tax: how they differ

Americans’ assets do not escape taxes after death. Taxable property can be cash and securities, as well as real estate, insurance, trusts, annuities and business interests, according to the Internal Revenue Service (IRS).

The most common “death taxes” Americans might see are inheritance taxes and inheritance taxes, although the two are different.

The main difference between an inheritance tax and an inheritance tax is that the former comes directly from the estate of the deceased person before that asset is distributed to its beneficiaries. During this time, the beneficiary is responsible for paying the inheritance tax as soon as he receives these assets.

Inheritance tax

Inheritance taxes come with high income thresholds, which means most estates for middle-to-low-income Americans will not be billed.

To determine how much you owe federally, you will need to calculate how much of your estate is taxable by subtracting the gross value of the estate along with all debts and expenses that are also passed on to eligible beneficiaries. A deposit is required in 2021 if the estate’s value is deemed to be greater than $ 11.7 million, according to IRS guidelines.

Federal estate taxes work like federal income taxes: estates are subject to a graduated tax rate that increases for each dollar amount that exceeds the reporting threshold. The tax rate starts at 18% on the first $ 10,000 of taxable transfers over the $ 11.7 million limit and reaches 40% on taxable transfers over $ 1 million. explanation of the Congressional Budget Office.

Twelve states and the District of Columbia also impose an inheritance tax, according to the Tax Foundation. They are: Connecticut, Hawaii, Illinois, Maine, Minnesota, Maryland, Massachusetts, New York, Oregon, Rhode Island, Vermont and Washington.

Tax rates in these states range from 20% to 10%.

When it comes to those who are required to report, Massachusetts and Oregon have the lowest exemption level of any state at $ 1 million, while Connecticut exempts estates from paying its estate tax so much. that the total value is less than $ 7.1 million.

The executor is responsible for ensuring that these debits are paid.

Inheritance tax

Once the estate has paid all required estate taxes and settled all financial obligations, it can pay the remaining assets to the heirs – who then become responsible for settling the estate tax. Their taxable amount is based on the specific amount distributed to them, rather than the total size of the estate.

Tax rates also depend on the relationship of the beneficiary with the deceased. Spouses, for example, are still exempt from inheritance tax. Immediate parents, such as children, are also often exempt or pay some of the lowest inheritance tax rates. Beneficiaries who are not related end up paying the highest tax rates.

Who should pay? These states have an inheritance tax

Inheritance tax rates differ by state. As of 2021, the six states that levy inheritance tax are:

  • Iowa (0-15%);
  • Kentucky (0-16 percent);
  • Maryland (0-10%);
  • Nebraska (1-18 percent);
  • New Jersey (0-16 percent); and
  • Pennsylvania (0-15 percent).

Maryland is the only state to charge both an inheritance and an inheritance tax, meaning that the full value of a deceased individual’s estate could be affected twice by levies. However, the state’s highest tax rate – 10% – is the lowest of the six states, and children, spouses, parents, grandparents, stepchildren, in-laws, siblings or other direct line descendants are all exempt.

Nebraska has the highest inheritance tax rate – 18% – that is charged to unrelated heirs. Children, however, pay a 1% tax rate, while nieces and nephews are taxed at 13%.

Pennsylvania, meanwhile, is the only other state outside of Nebraska that has decided to charge direct line heirs (children and grandchildren), with their tax rate at 4.5%.

How to avoid paying inheritance tax

If you want to reduce the tax burden on your estate and maximize the inheritance your beneficiaries receive, you will likely need to take action before your death.

Recipients may not have much to do to reduce their bills, but they can work with their descendants or relatives to find the best tax-saving strategy for passing on their wealth.

Give away goods before you die

If you think you are going to be hit by heavy inheritance and inheritance taxes, you may want to donate some of your assets before you die. The IRS generally excludes gifts of up to $ 15,000 per person each year from taxes.

Switch to a different state before you die

You can choose to move to a state that does not levy inheritance tax or inheritance tax to limit the portion of your estate that goes to the government after your death. When it comes to inheritance tax, it is the state where the deceased person lives that counts, not the residence of the beneficiary. For example, a person living in New Jersey does not have to pay inheritance tax if they inherited property from someone who lived in Montana.

Use a trust

A trust allows a third party, or a trustee, to hold and manage assets in a trust fund on behalf of a beneficiary. It allows a person to place assets in a trust while they are alive, while control of the trust is transferred after death to a designated beneficiary.

There are two types of trusts: revocable and irrevocable. With an irrevocable trust, there is no formal transfer of ownership upon death, which means no inheritance or inheritance tax.

Work with a tax expert

An expert can help you identify the best course of action to limit your tax bill to ensure you maximize the legacy you leave to your beneficiaries.

Does an inheritance count as taxable income?

For tax purposes, an inheritance is not normally considered taxable income unless it generates frequent returns, such as rental property or an asset that provides interest or dividends. This also applies to withdrawals you make from a 401 (k) or Legacy IRA.

You also want to be careful capital gains taxes. If you sell stocks, bonds, or other property that you received as part of an inheritance, capital gains taxes may apply to the profits you made.

At the end of the line

Not all Americans are subject to inheritance tax or inheritance tax, and many states have moved away from such taxes altogether. However, these “taxes on death” are always something that you will want to watch closely if you are hoping to pass the wealth on to your spouse, children, or any other heir.

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