How Much Can You Inherit Without Paying Taxes?

Every so often, Congress introduces bills to either reduce or repeal what are known as “death taxes.” Elimination of these levies tends to create controversy; one side argues that the estates of high net-worth descendants should pay their fair share in taxes. The other side argues that such a tax is unfair to those left behind. 

But the constant attention to both the federal estate tax and the less common state-driven inheritance tax leads to many questions. One such question is how much a beneficiary or heir can inherit without paying these taxes. To answer this, it’s a good idea to understand exactly what these taxes are and how much they might cost. With this information, it’s easier to introduce elimination or reduction strategies.

Defining “Death Taxes”

As can be surmised by their description, “death taxes” come into play when someone dies. Such levies are better known as the federal Estate Tax, and according to the IRS it is “a tax on your right to transfer property at your death.” This levy analyzes the departed’s asset ownership or interests and fair market values, then combines them into the “Gross Estate.” Specific deductions (such as mortgages, estate administration expenses, property passing to spouses, and charitable gifts) come into play, with the result being the “Taxable Estate.”

Some states also have their own estate taxes (in addition to the federal Estate Tax). And some states have another type of death tax known as inheritance tax. The difference?

  • Estate taxes (both state and federal) are paid by the departed’s estate before assets are distributed to heirs or beneficiaries. Seventeen states have estate taxes.
  • Inheritance taxes are paid by the recipients or beneficiaries after asset distribution. There are six states with inheritance taxes. 

Here’s an interesting fact: Maryland is the only state that has both estate and inheritance taxes. 

To Pay . . . Or Not to Pay

Because of the above, there is no one answer to the question of how much an individual can inherit without having to pay taxes. The response depends on several issues, such as the Estate Tax thresholds, where the beneficiaries or heirs live at the time of the decedent’s death, and the relationship between the two parties.

Estate Tax Thresholds

It’s important to understand that not all estates will be subject to taxes. On the federal level, the IRS sets limits—or thresholds—on estate values before they are taxed. The Federal Estate Tax threshold is:

  • $11.7 million (2021)
  • $12.0 million (2022)

Any estate exceeding the above thresholds could be taxed up to 40%.

Furthermore, the following states levy their own estate taxes, with lower thresholds and varying percentages, depending on the tax bracket.

State

Threshold Amount

Tax Percentage

Connecticut

$7.1 million

10.8%-12%

District of Columbia

$4 million

11.2%-16%

Hawaii

$5.5 million

10%-20%

Illinois

$4 million

0.8%-16%

Maine

$5.8 million

8%-12%

Maryland

$5 million

0.8%-16%

Massachusetts

$1 million

0.8%-16%

Minnesota

$3 million

13%-16%

New York

$5.9 million

3.06%-16%

Rhode Island

$1.6 million

0.8%-16%

Oregon

$1 million

10%-16%

Vermont

$5 million

16%

Washington

$1 million

10%-16%

Source: Tax Foundation

As such, if the departed lived any of the above states (or DC), the threshold for estate taxes is lower than that involving federal taxes. Furthermore, if a decedent’s estate located in any of the above states exceeds a value of $11.7 million (for 2021), double taxation could be likely.

Inheritance Tax Amounts

As mentioned above, inheritance taxes operate differently. These taxes are paid by beneficiaries and are calculated based on asset value and tax brackets. The following states levy inheritance taxes:

State

Tax Percentage

Iowa

0%-15%

Kentucky

0%-16%

Maryland

0%-10%

Nebraska

1%-18%

New Jersey

0%-16%

Pennsylvania

0%-15%

Source: Tax Foundation

Reducing or Eliminating Death Taxes

Whether such taxes are considered unfair or justified, it’s important to understand that not all estates will be subject to the levies. In 2020, for example, fewer than 0.1% of estates filed the tax forms, with only 0.04% of estates actually paying federal taxes. 

Additionally, the Estate Tax exemption is “portable” between spouses on both the federal and state levels. This means that spouses inheriting estates, no matter the value, will not have to pay taxes.

Finally, in states with inheritance taxes, not all beneficiaries need to pay; only distant relatives or non-related beneficiaries might be responsible for those expenses.

The best way to reduce or eliminate estate or inheritance taxes is to encourage the following:

  • Transfer part, or all, of the state to an irrevocable trust and transfer part of the estate to it
  • Gift funds to family and beneficiaries before death to reduce the estate size
  • Pass the entire estate to a spouse

The takeaway here is that while death taxes do exist, they can be mitigated and/or reduced. Planning before an individual’s death can help ensure that the entire estate value can be passed to future generations with minimal loss.

 

This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice, meeting the particular investment needs of any investor. Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.

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