It’s not something anyone likes to think about, but if a friend or family member passes away, you may inherit some of their money or property.
That inheritance, however, may come with some strings attached in the form of taxes.
Here’s what you need to know.
Inheritance tax vs. state tax
An estate tax is levied on the value of a deceased person’s belongings, properties, and financial accounts. The executor of the estate, the person responsible for making sure that the deceased’s wishes are being followed, is responsible for making sure the estate pays these taxes.
The people receiving an inheritance from the estate are not responsible for paying estate taxes, but the tax may affect the size of the inheritance that is passed on.
How much of the estate is taxed is dependent on both the size of the estate and the state where the deceased resided before they passed away.
As of 2018, the federal government assesses an estate tax on all estates exceeding $11.18 million in value. If the value of an estate is less than that amount, no federal estate tax is owed.
The federal estate tax works much like the income tax. The first $10,000 over the $11.18 million exclusion are taxed at 18%, the next $10,000 are taxed at 20%, and so on, until amounts in excess of $1 million over the $11.18 million exclusion are taxed at 40%.
|Amount in excess of $11.18 million||Taxes owed|
|$0 – $10,000||18%|
|$10,000 – $20,000||$1,800 + 20% of the amount over $10,000|
|$20,000 – $40,000||$3,800 + 22% of the amount over $20,000|
|$40,000 – $60,000||$8,200 + 24% of the amount over $40,000|
|$60,000 – $80,000||$13,000 + 26% of the amount over $60,000|
|$80,000 – $100,00||$18,200 + 28% of the amount over $80,000|
|$100,000 – $150,000||$23,800 + 30% of the amount of $100,000|
|$150,000 – $250,000||$38,800 + 32% of the amount over $150,000|
|$250,000 – $500,000||$70,800 + 34% of the amount over $250,000|
|$500,000 – $750,000||$155,800 + 36% of the amount over $500,000|
|$750,000 – $1 million||$248,300 + 38% of the amount over $750,000|
|$1 million or more||$345,800 + 40% of the amount over $1 million|
Currently, fifteen states and Washington D.C. levy estate taxes. Each state can set its own rates and the threshold value at which estates are taxed. For example, Massachusetts taxes any estate that surpassed $1 million in value, even though many of those estates are too small to be taxed federally.
Though you don’t pay these estate taxes directly as an inheritor, they do have an impact on your inheritance by reducing the size of the estate that you are inheriting from.
Inheritance taxes are distinct from estate taxes because they are paid by the individuals who receive an inheritance from an estate. Once the estate has paid all relevant estate taxes and settled and financial obligations, it can pay out the remaining assets to inheritors. At this point, the inheritors must pay any relevant inheritance taxes.
While there is no federal inheritance tax, six states: Nebraska, Iowa, Kentucky, New Jersey, Pennsylvania, and Maryland, do implement a state inheritance tax.
This tax rate varies based on where you live and the size of the inheritance. For example, Nebraskans might pay as much as an 18% tax on inheritances. Pennsylvanians won’t pay more than 15%.
Taxes on the sale of inherited investments and other property
When you receive an inheritance, much of the time, it won’t come to you as simple cash deposited to your checking account, ready to spend. You might receive part of the inheritance in the form of stock in a company or as physical real estate.
In most situations, when you sell property, you have to pay capital gains taxes. This is a tax on the difference in cost of an investment on the date it was purchased, known as the cost basis of the investment, and the amount it was sold for.
If you receive stock, bonds, or other property as part of an inheritance, you may owe capital gains taxes on the property when you sell it. These taxes often get confused for inheritance taxes, but it is important to remember the distinction.
Depending on how much the property is worth, you may not have to pay capital gains taxes when you sell. When you receive property as an inheritance, you do not need to use the original cost basis of the property for calculating taxes when you sell. Instead, you may step-up the tax basis to the value of the investment on the day the original owner passed away.
This can mean a significantly lower tax bill, especially if the original holder of the investment bought it a long time ago.