So, you just received a notice that you will inherit from your great aunt’s estate. A wonderful surprise, no doubt. Of course, an estate may be required to pay taxes to the government, but do heirs pay taxes on the inheritance they receive from someone’s estate? The answer depends entirely on which state you live in. Since state laws are always subject to change, you should check with competent counsel in your state if you are receiving an inheritance.
An “inheritance tax” is a tax imposed on money received from someone else’s estate after their death. Inheritance taxes apply a tax rate schedule to bequests made, depending on the class of beneficiary. For instance, surviving spouses and lineal heirs are generally taxed at a lower tax rate, or may be totally exempt from taxes. More distant or unrelated heirs, sometimes referred to as collateral heirs, will normally be taxed at a higher rate. The federal government does not have an inheritance tax. Inheritance taxes are only imposed at the state level. However, not all states impose an inheritance tax. In fact, only a few remaining states have continued to impose the tax.
The Estate Tax is a tax on the transfer of estate assets at your death. It is calculated by first making an accounting of everything you own or have some type of ownership interest in. The total value of all of these items is your "Gross Estate." Property that is generally included in your gross estate would be cash and securities, real estate, insurance, trusts, annuities, business interests and other assets. After certain deductions are allowed, to arrive at your "Taxable Estate," the tax is assessed on the net amount. The estate tax is imposed on the estate of the person leaving the property, not the beneficiary. Therefore, the key difference between an estate tax and an inheritance is who is responsible for paying the tax.
From 1924 through 2001, the federal estate tax allowed a dollar-for-dollar credit for state death taxes paid up to certain maximum limits. At that time, all states imposed estate taxes up to the amount of the federal credit. Some states also imposed additional inheritance or estate taxes. However, from 2001 to 2005, Congress phased out the federal credit for state death taxes. Once that happened, most states stopped imposing estate or inheritance taxes. Now, only seven states continue to impose inheritance taxes: Iowa, Kentucky, Maryland, Nebraska, New Jersey, Pennsylvania, and Tennessee. The Tennessee tax is scheduled to be eliminated after December 31, 2015. Nevada does not impose an inheritance tax.
Another common question is whether the recipient of a gift is required to pay taxes if it is not an inheritance, but the donor is still living. In most cases, the person making the gift is responsible for paying any required taxes, and reporting the gift to the IRS and to their state, if necessary. The person receiving the gift should not have any immediate tax consequences. Gifts generally are not included as part of the recipient’s taxable income. However, there may be future tax consequences, such as a capital gains tax when the gifted property is later sold.
If you have questions regarding inheritance taxes, or any other estate planning needs, please contact Anderson, Dorn & Rader, Ltd., either online or by calling us at (775) 823-9455.