Typically, only large estates have to pay out taxes, it is likely that you, as a beneficiary, will not have to pay out any taxes.
Inheritance Tax
An inheritance tax is a tax the beneficiary must pay upon receiving an inheritance.
Inheritance Tax – Federal Level
The federal government does not impose any inheritance tax on beneficiaries, and inheritances typically are not subject to any income tax.
Inheritance Tax – State Level
As of 2018, only six states collect inheritance tax: Pennsylvania, New Jersey, Nebraska, Maryland, Kentucky, and Iowa. All other states do not collect any inheritance tax. It does not matter in which state the beneficiaries live, only in which state the deceased resided. Therefore, if the deceased did not reside in one of the six states listed, the beneficiaries will not have to pay state inheritance taxes.
All six of these states do not tax any property passing to the surviving spouse. Only Pennsylvania and Nebraska tax any property passing to the children or grandchildren.
Inheritance Tax versus Estate Tax
Inheritance taxes and estate taxes are not the same thing. Inheritance taxes are paid by the beneficiary while estate taxes are paid from the deceased’s estate.
Estate Tax
Estate taxes are taxes on the individual’s right to transfer property to others when he or she dies.
Estate Tax – Federal Level
Any estates worth less than $11.4 million are exempt from paying estate taxes as of 2019. Any estates larger than that are taxed at rates as high as 40%. The assets are generally taxed based on their current market value, and not what the deceased originally paid for them.
Estate Tax – State Level
Washington, Vermont, Tennessee, Rhode Island, Oregon, New York, New Jersey, Minnesota, Massachusetts, Maryland, Maine, Illinois, Hawaii, Delaware, and Connecticut all collect state estate tax. The threshold level for the states varies but all have a level lower than the federal level. However, many estates still fall beneath the threshold levels and estate taxes do not need to be paid.
Capital Gains Tax
Capital gains taxes do not apply to cash but they do on other assets. The capital gains tax is applied to any difference between the value of a certain asset and the amount the beneficiary sells it for. The base of the sold asset is stepped to its value at the time the deceased passed away. Simply put, if you sell a house inherited from your parents, you will only pay capital taxes on the difference in the value of the home from the time the deceased passed away and the time the beneficiary sold the home. Inheritances qualify for the long-term capital gains tax rate, which is typically lower than the income tax rate of the beneficiary.
Ways to Reduce Inheritance Tax
There are several ways to minimize the taxes paid for inheritances, including:
- Giving the assets away as gifts before passing away. Many states do not tax gifts.
- These gifts do not have to be cash, but can be other assets such as stocks, cars, and other property.
- Consult a qualified tax accountant
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