Quick Summary: Are Inheritances Taxed?
In most cases, an inheritance is not considered taxable income at the federal level. However, your tax liability depends on your state of residence and the type of assets received. While you generally won’t pay federal income tax, you may be subject to a State Inheritance Tax if you live in Iowa, Kentucky, Maryland, Nebraska, New Jersey, or Pennsylvania. Additionally, withdrawals from inherited retirement accounts (like an IRA or 401(k)) are typically taxable as income.
Key Tax Facts:
- Federal Level: Inheritances are not treated as taxable income by the IRS.
- Inheritance Tax: Only six states levy this tax directly on the beneficiary.
- Estate Tax: Paid by the estate itself before you receive your share; beneficiaries are not personally billed for this.
- Exceptions: Distributions from inherited retirement plans and income generated by inherited assets (rent, dividends) are taxable.
As Benjamin Franklin famously said, nothing is certain but death and taxes. If you have recently lost a loved one, you may be wondering exactly how much the government will take from your inheritance. The answer depends on two main factors: where the deceased lived and your relationship to them.
While the short answer is that most beneficiaries pay little to no tax, certain situations can lead to a tax rate as high as 18%.
Understanding the Two Types of Death Taxes
Your inheritance can be taxed in two distinct ways, often by different collectors:
- Estate Tax: This is collected from the estate’s total value during the probate process before funds are distributed. Because the estate pays this directly, beneficiaries are generally not responsible for it.
- Inheritance Tax: This is a tax you, the beneficiary, are responsible for paying on the specific amount you receive.
The good news is that the federal government does not have an inheritance tax. Furthermore, the federal estate tax only applies to very large estates (valued over $11.7 million as of 2021).
State Inheritance Tax: The Six-State Rule
You will only be subject to a state-level inheritance tax if the deceased lived in one of these six states:
- Iowa (Max rate: 15%)
- Kentucky (Max rate: 16%)
- Maryland (Max rate: 10%)
- Nebraska (Max rate: 18%)
- New Jersey (Max rate: 16%)
- Pennsylvania (Max rate: 15%)
In these states, your relationship to the deceased matters. Surviving spouses almost always pay nothing, and children often pay very low rates or are exempt entirely.
Exceptions: When You WILL Owe Taxes
Even if you don’t owe an inheritance tax, you may owe income tax in these scenarios:
- Retirement Accounts: If you inherit an IRA or 401(k) and take distributions, that money is usually taxed as ordinary income.
- Income-Producing Assets: If you inherit a rental property or stocks, you don’t pay tax on the value of the asset itself, but you do pay tax on any future rent or dividends they produce.
If you are facing a long probate wait and need your funds now, an inheritance advance can help you bypass the typical 1.5-year delay without the burden of monthly tax-like payments or interest.
Frequently Asked Questions
Generally, no. Inheritances are not considered income by the IRS, so you do not need to report the value of the cash or property you received on your federal income tax return (Form 1040).
As of 2024, only six states have an inheritance tax: Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. Each state has different exemption levels based on how closely you were related to the deceased.
Inheriting the house itself is usually tax-free at the federal level. However, if you sell the house later, you may owe capital gains tax on any increase in value from the date of the owner’s death. If the house is in one of the six states mentioned above, you may also owe a state inheritance tax.