What is an inheritance tax?
An inheritance tax is a state tax that people pay when they receive money or property from the estate of a person who has died. Unlike the federal estate tax, the heir of the property is responsible for paying the tax, not the estate. However, as of December 2016, only four states impose an inheritance tax.
In the U.S., the federal government collects the estate tax while the state government collects the inheritance tax. Both work on the same principle. With an inheritance tax, a person who is named in a legal will as the heir of assets from an estate may be responsible for paying tax to the state. This is not the same as taxes imposed on the property itself, but due only for the right to assume ownership. The inherited assets are assessed and, depending on their estimated value and the heir’s relationship to the deceased owner, a tax may or may not be imposed.
Inheritance tax example
Once the estate’s executor has divided the properties and other assets, and distributed them to the beneficiaries, the inheritance tax will be imposed. The amount of tax is calculated separately for each individual beneficiary, who is responsible for paying the tax. To provide a simple example, a state may charge a 5 percent tax on all inherited assets worth more than $2 million. So if a person leaves $5 million to an heir in his will, the heir would only pay tax on $3 million, which amount to $150,000. The state would require the beneficiary to report this information on an inheritance tax return.
The U.S. federal government doesn’t impose an inheritance tax. The four states that currently levy an inheritance tax are Iowa, Kentucky, Nebraska and Pennsylvania. The state laws regarding inheritance tax are subject to change, so a person who receives an inheritance should check with their state’s tax agency. The top tax rates on inheritances range from 4.5 percent to 18 percent of the value of assets inherited.
Depending on his relationship to the deceased person, the heir may receive a tax exemption or reduction in the amount of inheritance he should pay. For instance, most states exempt spouses from tax when they inherit the assets from another spouse. Dependents such as the children may also qualify for the same exemption. Typically, the higher rates of tax will be imposed on heirs with no familial relationship to the decedent.