Inheritance tax: what it is and how to avoid it - NerdWallet

Inheritance taxes are often a troubling thought for heirs, but rarely is it a real problem: only a small number of states levy inheritance taxes, so the likelihood that you will pay is extremely small. However, if you live in a state that levies such a tax, the specific conditions of your situation can make a significant difference in the tax payment.

Inheritance tax: definition

Inheritance tax is a tax on inherited assets from a deceased person. The tax is paid by the heir to the assets, and rates can vary depending on the size of the inheritance, and the heir's relationship to the deceased. Inheritance tax returns and tax contributions are generally due in''Within a few months of the testator's death. Find trusted fiduciaries, financial advisors and planners to help you reach your financial goals. Sign up for a free consultation today.

Is an inheritance taxable?

Inheritances may be taxable, especially when passed to you from someone who is not a close family member. The spouse of the deceased is usually exempt from taxation, which means that money and items passed on to them are not subject to inheritance tax. Children of the deceased are also sometimes exempt from taxation.

Inheritance tax rates

Inheritance tax rates are set by the state, so where you live, the specific terms of your inheritance, and your''s own tax situation are factors affecting how much tax you will have to pay. Is there a federal inheritance tax?

There is no federal inheritance tax.And, in fact, only six states - Iowa, Kentucky, Maryland, Nebraska, New Jersey and Pennsylvania - levy a tax on inherited assets from 2023.

In 2021, Iowa passed legislation to phase out the inheritance tax in its state, eliminating it entirely for deaths occurring after Jan. 1, 2025.

Inheritance tax vs. estate tax

Inheritance tax and estate tax are two different things. Inheritance tax is what an heir has to pay when they receive''inheritance. Estate tax, on the other hand, is the amount that is deducted from an inherited estate upon a person's death based on the value of the estate. One, both, or neither of these taxes can be taken into account at death.

Another key difference: while there is no federal inheritance tax, there is a federal estate tax.

Since the estate tax and inheritance tax are different things, some people sometimes have to deal with a double shockwave. For example, Maryland has an estate tax and an inheritance tax, which means that a testator may be required to pay the tax to both the IRS and the state, and then the beneficiaries will have to pay the state again out of the resulting balance. However, this is not the norm across the country.

States that have estate taxes, inheritance taxes, or both:

Be careful with capital gains taxes

If assets increase after you inherit them, you may need to pay capital gains tax if you sell the assets. The rate of tax''Capital gains tax depends on, among other things, the profit you make. For example, if your father leaves you a stock portfolio worth $200,000 on the day he dies and you sell it for just $350,000 two years later, you may have to pay capital gains tax on the $150,000 gain.

Some types of inheritances can also create taxable income. For example, if you inherit an IRA or 401(k), the deductions you receive may be taxable.

Different states may have their own capital gains tax rules, so it is recommended that you seek qualified advice.

Prepare to simply file a tax return at a flat rate of $50 for each''occasion

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How to avoid inheritance tax

If you live in a state that levies inheritance taxes, there are several ways to minimize taxes on transferred assets. Getting help from a qualified tax expert can be key, but one common element of legacy planning is to transfer assets before death. Many states do not impose gift taxes on gifts. Keep in mind that gifts'. 'Doesn't necessarily have to be money - shares, bonds, cars and other assets also count.

There is not much heirs can do to avoid inheritance tax after they have inherited an estate. However, those who leave an estate can take steps in advance to ensure heirs are in the best position possible. These legacy planning tools include living trusts, irrevocable trusts and grantor retained annuity trusts.

Some useful links from IRS