As a wise man once said, nothing is certain but death and taxes. That wise man, by the way, was Founding Father Benjamin Franklin. If a relative of yours has recently followed old Ben to the great beyond, both death and taxes may be on your mind—namely how much tax will the government Mr. Franklin helped create put on my inheritance? The answer, as with anything tax related, depends on a number of factors including which state the deceased lived and what your relationship to them is. While the short answer is yes an inheritance is taxable, depending on your particular situation you could pay nothing, or you could pay as much as 18% of the value of the inheritance.
Your inheritance can be taxed in two ways, from two different collectors. Your inheritance can be subject to an inheritance tax and an estate tax, by the federal government and/or the state government. Some good news: you’re only responsible for paying inheritance tax, as the estate tax comes directly out of an estate, during the probate process, before funds are distributed. More good news regarding the federal government: In most cases, assets you receive as a gift or inheritance are not taxable income at the federal level. However, if the assets you inherit later produce income (like earning interest or dividends, or you collect rent from a property), that income is likely taxable and up to you to report. Thirdly, in this good news trifecta, you will only be subject to an inheritance tax if you live in one of these six states: Iowa, Kentucky, Maryland, Nebraska, New Jersey, or Pennsylvania. How much tax you owe depends on your relationship to the deceased—surviving spouses generally pay nothing, and children pay either nothing or very low tax rates. The tax rate typically increases the more distantly related you are. Here is the max inheritance tax rate for each of the states with an inheritance tax:
- Iowa: 15%
- Kentucky: 16%
- Maryland: 10%
- Nebraska: 18%
- New Jersey: 16%
- Pennsylvania: 15%
The inheritance tax is only levied by states, but both the federal government and states may collect estate tax. However, the federal estate tax only applies to estates that are worth more than $11.7 million (as of 2021). Twelve states and the District of Columbia levy their own estate taxes, with rates starting as low as 10% in Connecticut, and increasing as high as 20% in Washington state. And the estate tax is paid before your portion of the inheritance is passed on to you, so you don’t have to pay it.
Having said all that, the main thing is this: Beneficiaries generally don’t have to pay income tax on money or other property they inherit, aside from the exceptions described above and on money withdrawn from an inherited retirement account (IRA or 401(k) plan).
If you are due a large inheritance, be sure to study the laws in your state. It is also recommended to consult with a financial advisor who can help you put your inheritance to work for you in the smartest way possible. If you need your inheritance funds sooner than 1.5 years (the average length of probate in the USA), you may consider an inheritance advance. Click here for more info on that option.