Inheritance Tax

The estate tax gets a lot more attention, but people who inherit property might have to pay a different death tax, called an inheritance tax, which is imposed by six (soon to be five) states. If you inherit property from someone who lived in one of these states, you might end up needing to use some of your inheritance to pay this tax.

Inheritance tax is a state tax only; the federal government does not have an inheritance tax, though it has a federal estate tax. Some states also impose a state estate tax. Maryland is the only remaining state that has both a state estate tax and a state inheritance tax.

Who Pays State Inheritance Tax

States that currently impose an inheritance tax include:

• Iowa (but Iowa is in the process of phasing out its inheritance tax, which was repealed in 2021; for deaths in 2021-2024, some inheritors will still have to pay a reduced inheritance tax)
• Kentucky
• Maryland
• Nebraska
• New Jersey
• Pennsylvania

If the person who left you money lived in one of these states, or owned property there, you might owe inheritance tax, even if you don't live in that state. So, for example, if you live in California and inherit property from your aunt who lived 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. The specifics will vary depending on the state where the deceased person lived. In all states, surviving spouses are exempt from paying inheritance tax. Some states will also exempt children, grandchildren, and other close family members, while others will tax them at a much lower rate than other inheritors. The actual tax rate often increases the less related you are to the deceased person, and sometimes it also increases depending on the amount of property you inherit.

For example, in Nebraska:

• 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
• more distant relatives pay 13% for amounts over $15,000, and
• non-relatives pay 18% on amounts over $10,000.

The top inheritance tax rate in any state is 18%.

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 might 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 (POD) bank account—the POD beneficiary would be responsible for paying any tax due.

Why Both Inheritance Tax and (State or Federal) Estate Tax May Be Due

Some states, and the federal government, also impose estate tax when someone dies. Federal estate tax affects only the largest estates, those worth more than $11.7 million for deaths in 2021. Because the tax exemption is so high, and because all property passing to a surviving spouse is exempt, it's estimated that more than 99.5% of estates do not owe any federal estate tax. But if the deceased person left behind a very large estate and lived in one of the states listed above, it's possible that both a federal estate tax and a state inheritance tax will be due.

As for state estate taxes, currently, Maryland is the only state that has both state estate tax and inheritance tax—but it's not as bad as it sounds, since the estate can subtract any inheritance taxes paid from the amount of state estate tax due.