The estate tax gets a lot more attention, but people who inherit property may also have to pay a separate inheritance tax, which is imposed by six states. If you inherit property from someone who lived in one of these states, you may end up paying some of your inheritance in taxes.
Who Pays State Inheritance Tax
States with an inheritance tax include:
- Indiana (retroactively repealed effective January 1, 2013)
- New Jersey
You may get a tax bill even if you don’t live in one of these states. If the person who left you money lived in one of these states, or owned property there, the state will collect the tax from you. So if you live in California and inherit property from your aunt who spent her life in Pennsylvania, you might owe Pennsylvania inheritance tax.
Whether or not you will owe inheritance tax depends on how closely related you were to the person who left you money. It doesn’t matter, in most states, how big the whole estate is or how much you inherit. You might owe state inheritance tax even if you inherit a small amount of property.
If you inherit from your spouse (or registered domestic partner or civil union partner), you are exempt from inheritance tax in all states. Charitable beneficiaries may also be exempt from the tax. Depending on state law, children who inherit either pay nothing or pay low rates.
The less closely you are related, the higher the tax rate. For example, in Maryland, parents, siblings and other close relatives can inherit $40,000 tax-free, and pay just 1% of the market value of inherited property over that amount. Tax rates for more distant inheritors start at 13% for amounts over $25,000. In most states, the top rate, paid by the most distant relatives, is less than 20%.
The Inheritance Tax Return
If a state inheritance tax return is required, it’s the executor’s job to file it. Only one return needs to be filed, no matter how many beneficiaries are subject to inheritance tax.
If there is a formal probate court proceeding, the executor may have to file the return and show that all inheritance taxes have been paid before the estate can be closed. If an asset doesn’t go through probate—for example, a payable-on-death bank account—the POD beneficiary would be responsible for paying any tax due.
Why Both Inheritance Tax and Estate Tax May Be Due
Some states, and the federal government, also impose estate tax when someone dies. Estate tax is assessed on the whole estate, and the amount due is paid before property is distributed to the people who inherit it.
Federal estate tax affects only the largest estates, those worth more than $5.25 million for deaths in 2013 and $5.34 million in 2014. Because the tax exemption is so high, and because all property passing to a surviving spouse is exempt, it’s estimated that more than 99.7% of estates do NOT owe any federal estate tax.
State estate tax is also based on the value of the whole estate. Estates that aren’t large enough to pay federal estate tax may be subject to a state tax. For example, in Maryland, estates valued at more than $1 million may be taxed. Still, most estates don’t owe either state or federal estate tax. State tax rates are much lower than federal ones.