The subject of taxation on inheritances can be confusing for someone who is not in the field. You may have heard the terms “inheritance tax” and “estate tax,” and you will naturally have questions.
Are these two different ways of describing the same tax, or are they separate taxes? Do the terms refer to income taxes on inheritances? What about the distinction between federal and state taxes?
These are good questions, and we will provide the answers in this post.
The terms do not refer to income taxes, because generally speaking, you do not have to report an inheritance when you file your returns. This is because the person who left you the assets paid their taxes, and the estate is a remainder that was left over after taxes were paid.
There is an exception when it comes to distributions of the earnings that are generated by assets in a trust. Plus, if you inherit a traditional individual retirement account, you would have to pay taxes on the distributions.
Federal Estate Tax and Gift Tax
We have a federal estate tax in the United States, but you will probably be exempt, because there is a high exclusion. The first $11.7 million can be transferred tax-free. But if you are exposed, you are looking at a 40 percent maximum rate.
There is also a gift tax, and it is unified with the estate tax. This exclusion applies to large gifts and the estate will be transferred after you are gone.
The federal estate tax marital deduction can be used to transfer unlimited assets to your spouse tax-free, and a surviving spouse can use their deceased spouse’s exclusion.
State-Level Estate Taxes
In addition to the federal estate tax, residents of 12 states in the union can potentially be exposed state-level estate taxes.
The state-level exclusions are lower than the federal exclusion. At the low-end, Oregon and Massachusetts have $1 million exclusions, and New York has the highest exclusion at $5.93 million.
We do not have a state-level estate tax in Kansas, but if you own property in a state that has its own estate tax, it would be applicable if the property’s value exceeds the exclusion amount.
Now we can move onto inheritance taxes. As we have stated, an estate tax is levied on the entire taxable portion before it is distributed to the heirs. Inheritance taxes can be imposed on transfers to each individual inheritor who is not exempt.
There are 6 states in the union that have inheritance taxes, and once again, we are in the clear. For your information, the six states are Iowa, Kentucky, Pennsylvania, New Jersey, Maryland, and Nebraska.
If you inherit property that is located in one of these states, the inheritance tax in that state would be a factor. That’s the bad news, but the good news is that close relatives are typically exempt.
Download Our Estate Planning Worksheet
We have prepared an estate planning worksheet that you can go through to gain a more thorough understanding of this important process. This resource is being offered free of charge, and you can get your copy if you visit our worksheet access page and follow the simple instructions.
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