Inheritance tax is an estate planning term that refers to a tax on property inherited on a person’s death. The person inheriting the money or property must pay the tax, which is levied by the state in which the heir lives, or where the real property resides. Inheritance taxes are state taxes, and only a few states still impose them. The rates for, and exemptions from inheritance taxes vary depending on the value of the property inherited, and the recipient. To explore this concept, consider the following inheritance tax definition.
Definition of Inheritance Tax
- A tax imposed on individuals who inherit money, or property, or other assets from a deceased person.
1835-1845 U.S. Tax Code
What is Inheritance Tax
When a person inherits money, personal property, real property, or other valuable assets from a deceased person, those assets may be taxed, based on their value. The amount of the tax varies by state, as well as by the relationship between the heir and the deceased person. As of 2015, only six states still impose inheritance tax. Any inheritance tax due is in addition to any federal estate taxes imposed.
The states that impose an inheritance tax as of 2015 are:
- New Jersey
After an executor of the estate divides the assets and distributes them to the proper beneficiaries, the inheritance tax is calculated. Each individual beneficiary is responsible to pay the tax, the rates of which vary from as little as 1%, to as high as 20% of the value of the inheritance.
If the deceased person lived in a state that imposed inheritance taxes, the beneficiary may be subjected to the tax. The same may be true if the beneficiary lives in a state that imposes such taxes, even if the deceased person did not.
Inheritance Tax Exemptions
Some people may qualify for inheritance tax exemptions, depending on their relationship to the decedent. Most states provide exemptions for the spouse of the deceased, and some provide exemptions for the decedent’s other dependents, such as children. As an example of inheritance tax, the amount subject to inheritance tax exemption may be 100% of the tax, or only a portion of it. In most cases, a non-relative inheriting assets will be required to pay a higher tax that a relative.
As of 2015, inheritance tax exemptions imposed by states that still have them include:
- Iowa – If the amount inherited is less than $25,000, the beneficiary is not required to pay an inheritance tax. The same is true, regardless of the value of the estate, if the beneficiary is the surviving spouse, grandparent, parent, or lineal ancestor.
- Kentucky – Spouses, parents, children, grandchildren, and siblings are exempt. Other relatives are subject to a 16% tax rate if the amount of the inheritance is over $1,000.
- Maryland – All relatives are exempt from inheritance taxes. Non-relatives are required to pay taxes on any inheritance over $1,000.
- Nebraska – Any beneficiary is exempt if the amount inherited is less than $40,000. The same is true if the beneficiary is a parent, grandparent, spouse, child, or sibling of the decedent.
- New Jersey – Close relatives are exempt. Non-relatives are taxed on anything exceeding $25,000. The tax rate goes up as the amount inherited increases.
- Pennsylvania – All close relatives are exempt from inheritance tax. The tax rate for others depending on the relation and the amount.
Difference Between Estate Tax and Inheritance Tax
Contrary to popular belief, there is a difference between estate tax and inheritance tax. Although the terms seem interchangeable, they are not, at least when it comes to taxes. The primary difference is just what is taxed. The federal estate tax applies to the value of the assets owned by the deceased person. This tax must be paid out of the estate before anything can be handed down to the heirs, and has nothing to do with heirs who will receive a portion of what is left over.
An inheritance tax is levied by individual states, and the amount is based on the value of the assets given to an heir. Once an individual receives an inheritance, the amount of inheritance tax he must pay will be based on the amount of that inheritance, as well as his relationship to the deceased. Only a handful of states still levy inheritance tax.
Example of Inheritance Tax
When Grandpa George passes away, he leaves an estate worth about $240,000. His will divides his estate among his children and grandchildren. Before anyone can receive an inheritance, however, the executor of the will must calculate the amount of estate tax due, and pay that amount to the IRS. The amount of assets remaining will be divided according to Grandpa George’s wishes.
Granddaughter Madelaine is given an inheritance of $10,000, but her state has an inheritance tax. When she confers with a tax professional, Madelaine discovers that, as a grandchild, her inheritance will be taxed at a rate of 4.5%. In Madelaine’s state, sibling heirs are taxed at 12%, and other heirs are taxed at 15%.
Domestic Partner Ordered to Pay Inheritance Taxes
After her domestic partner died, Claudette A. Lugano filed for an inheritance tax exemption, but she was denied. Lugano argued that she was entitled to receive the exemption on her partner’s federal pension, as she was a recognized domestic partner. Lugano’s partner was a federal employee, and the couple had filed forms with the government stating their relationship, in order for Lugano to be eligible for certain benefits. Having done this, the couple was under the impression that they had met the requirements to be recognized as domestic partners.
Lugano filed a civil lawsuit in the New Jersey Tax Court. The court disagreed, ruling that the couple failed to file all of the necessary forms, and that Lugano did not qualify for the inheritance tax exemption. Lugano appealed the matter to no avail. The Appellate Division of the Superior Court of New Jersey confirmed that the trial court had been correct in that not all of the required documents had been filed, and refused to hear the case. Lugano was required to pay over $100,000 in inheritance taxes to the state of New Jersey.
Related Legal Terms and Issues
- Beneficiary – A person named in a will or trust as the intended recipient of assets or property.
- Decedent – A person who has died.
- Estate Planning – The act of preparing for the transfer of a person’s wealth and assets after his or her death. This often involves the creation of a will.
- Executor – A person appointed to carry out the wishes contained in a decedent’s will.
- Exemption – A relief of responsibility from carrying out a responsibility, or from paying taxes on a specified amount of income.
- Jurisdiction – The legal authority to hear legal cases and make judgments; the geographical region of authority to enforce justice.
- Personal Property – Any item that is moveable and not fixed to real property.
- Real Property – Land and property attached or fixed directly to the land, including buildings and structures.