What Is Inheritance Tax and How Much Is It?

Back in the early 18th century, Christopher Bullock published his one-act play, “The Cobbler of Preston.” Based somewhat loosely on another, famed playwright’s “Taming of the Shrew,” Bullock introduced a somewhat innocuous phrase for its time: “’Tis impossible to be sure of any thing but Death and Taxes.”

That phrase passed through Daniel Defoe’s “The Political History of the Devil” (published in 1726), and eventually ended up in Benjamin Franklin’s well-known 1789 letter to Jean-Baptiste Leroy:

“Our new Constitution is now established, and has an appearance that promises permanency; but in this world nothing can be said to be certain, except death and taxes.”

More than two centuries later, death and taxes are still around. In fact, in some cases, these two concepts have a somewhat symbiotic relationship. This is especially the case when it comes to the inheritance tax. 

Sometimes known as a “death duty,” the inheritance tax is often confused with the estate tax. But these levies are very different from one another. Understanding the differences is important, especially when it comes to setting up trusts, and providing for beneficiaries.

Death Tax Differences

Two main differences exist between estate taxes and inheritance taxes:

Who/What Levies It

The inheritance tax is a levy imposed by certain states: six, to be exact.

Conversely, there is no such thing as a federal inheritance tax. It doesn’t exist. Rather, the federal government levies an estate tax on estates with larger thresholds ($11.7 million in 2021 and $12 million in 2022). Adding additional confusion to the matter, 12 states and the District of Columbia also levy their own state taxes, in addition to the federal estate tax.

To summarize:

  • The inheritance tax is NOT a federal tax, but is levied by six states.
  • The estate tax IS a federal charge; additionally, 12 states and DC also collect estate taxes.

Who/What Pays It

The other difference between these levies involves what, exactly, is taxed—and where:

A decedent’s estate pays federal estate taxes before assets are distributed to heirs. The taxed amount is calculated based on the estate’s value. 

State estate taxes are collected by 12 states (and the District of Columbia), and depend on where the departed lived at the time of death. For example, if the decedent lived in Maryland, the state might collect an estate tax. If the departed lived in Texas, no state estate tax would be imposed; Texas doesn’t collect estate taxes.

Inheritance taxes differ from both examples above, as the beneficiaries of the estate’s assets are responsible for paying them. Furthermore, these taxes are levied by the state in which the beneficiary lives, rather than where the decedent resided. Returning to the above example, if the decedent died in Texas while the inheritor resides in Maryland, the inheritor would be responsible for paying inheritance taxes. 

The main point here is that estate taxes are based on the value of an entire estate, which pays the levies prior to asset distribution. The inheritance tax is based solely on the value of the inheritance, and the beneficiary is responsible for payment.

However, as is the case with just about anything connected to death and taxes, there are exceptions to the above inheritance tax rules, as well.

It All Depends . . .

Moving on, the question involving how much inheritance tax is, or who actually pays it, the answer is: “it depends.” For one thing, the beneficiary’s relationship to the deceased can determine whether inheritance tax will be charged or not. In most cases, spouses won’t be on the hook for those charges. In other cases, immediate relatives might also be exempt.

Distant relatives or beneficiaries unrelated to the departed could be responsible for inheritance taxes. How much might they pay? Again, it depends on the states involved. Tax liability is determined as a percentage based on asset value, and can differ, based on the amounts, below:

State

Inheritance Tax Rate

Iowa

4%-12%

Kentucky

4%-16%

Maryland

10%

Nebraska

1%-18%

New Jersey

11%-16%

Pennsylvania

4.5%-15%

 

And there’s more. When it comes to inheritance taxes, many beneficiary categories exist, depending on the relationship with the decedent and tax brackets. Furthermore, if those assets are sold later for a profit, the beneficiary could be on the hook for capital gains taxes.

Death Tax Strategies

Though inheritance tax differs from estate taxes, both can be burdensome to wealthy individuals and their heirs and designated beneficiaries. It is possible to reduce or even avoid inheritance taxes through various strategies, such as setting up irrevocable trusts or directing assets to exempt individuals. Qualified tax professionals and/or financial planners can assist in such endeavors.

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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