Certain regions impose inheritance taxes on assets. This is different from an estate tax, which is charged on the deceased's whole estate before asset distribution. Instead, inheritors pay inheritance taxes.

Only six US states have inheritance taxes as of 2023. The state where the dead lived or had property, the inheritance value, and the beneficiary-deceased connection might all affect this tax. Notably, these taxes are usually paid the year after inheritance.

Inheritance tax is applied to large estates. It is calculated based on the estate's total value before the assets are passed on to the beneficiaries. Additionally, income tax may be levied on any earnings from the estate. However, no federal inheritance tax is imposed on the recipients of these assets.

Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania have inheritance taxes as of 2023. You may pay inheritance tax depending on the state's regulations, your connection to the dead, and the amount of your inheritance. This tax may apply if the deceased resided or held property in an inheritance-tax state.

US Inheritance Tax Thresholds

Inheritance tax laws vary significantly, depending mainly on the state and the familial connection between the beneficiary and the deceased.

In cases where a spouse inherits property or assets, they are exempt from paying inheritance tax. This means if a person inherits something from their spouse, like a condo, they won't face inheritance taxes in any of the states that impose them. This rule also uniformly applies to same-sex couples following a Supreme Court decision.

For children and grandchildren, the tax scenario is a bit different. In states like New Jersey, Kentucky, Iowa, and Maryland, they're not subjected to inheritance taxes upon receiving an inheritance. However, in Pennsylvania and Nebraska, and in situations involving other relatives, there's a likelihood of incurring inheritance taxes.

It's crucial to consider state-specific inheritance tax thresholds in the US. Assets received by beneficiaries are subject to inheritance tax depending on this variation.

Let's break down the specifics by state:

• Iowa: In Iowa, inheritance tax-free estates are under $25,000. This means that if you inherit property or assets from an estate of this size, you won't owe any inheritance tax. It's a significant relief for beneficiaries receiving smaller estates. Besides the estate value threshold, Iowa exempts spouses and direct descendants or ascendants (like children and parents) from inheritance tax. Charities also enjoy an exemption of up to $500. For others, the tax rate varies between 3% and 9%.
• Kentucky: Offers total exemption for immediate family members and partial exemptions for other recipients. Based on the inheritance size, the tax rate here slides between 4% and 16%.
• Maryland: Like Iowa, immediate family members and charities are fully exempt, with a flat 10% tax rate for other beneficiaries. Maryland sets a higher bar, exempting inheritances from estates smaller than $50,000. This exemption threshold is double that of Iowa, highlighting the diversity in state-level tax policies.
• Nebraska: Showcases a dynamic structure with varying exemptions and rates rising in 2023, catering to different beneficiary categories.
• New Jersey and Pennsylvania: Both states follow similar exemption patterns, with Pennsylvania having a unique tax rate system based on the beneficiary's relationship to the deceased.

Planning Strategies to Minimize Inheritance Tax

There are several effective methods to reduce the tax burden on your heirs when dealing with inheritance tax.

• Firstly, consider life insurance. When allocated to a specific beneficiary, the proceeds from these policies generally do not fall under the purview of inheritance tax. This makes life insurance a strategic tool for asset transfer without adding to the inheritance tax burden.
• You can also gift assets during your lifetime. This strategy works well because many states don't tax gifts. This wealth distribution can significantly reduce your estate's taxable value, reducing inheritance tax.
• Lastly, the use of irrevocable trusts stands out as a sophisticated method for estate planning. Transferring assets into such a trust effectively removes them from your estate. This means they are no longer considered part of your taxable estate upon death, thus lowering the potential inheritance tax. Establishing a trust also allows for controlled distribution of assets, ensuring your wishes are respected.

Differentiating Between Inheritance Tax and Estate Tax

It's common to confuse inheritance and estate taxes, but they differ fundamentally.

Both taxes are calculated based on the market value of the deceased's property, typically valued at the time of their death. An estate tax is charged on the total value of the deceased's estate and is paid out of the estate itself. In contrast, an inheritance tax is imposed on the value of what a beneficiary inherits and is paid by the beneficiary.

The difference between an estate tax and an inheritance tax might not be noticeable for a single heir, even if the rates and exemptions are the same. However, there are instances where an inheritance might be subject to both taxes.

The IRS sets the threshold for federal estate tax. For example, estates valued over $12.06 million in 2022, increasing to $12.92 million in 2023, must file federal estate tax returns. If the estate is transferred to a surviving spouse, it's exempt from this tax.

A beneficiary might face federal and state inheritance tax if the estate's value exceeds the federal threshold and the deceased lived in a state with inheritance tax. The estate is first taxed at the federal level before distribution, and then the inheritance is taxed at the state level.

Additionally, heirs could be subject to state estate taxes. As of 2023, 12 states and the District of Columbia impose their estate taxes. These state-level taxes typically have lower exemption thresholds than the federal estate tax, with some being as low as $1 million. Therefore, residents in these states are more likely to encounter state estate taxes than federal ones.