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Is My Inheritance Taxable?

Written By: MB Group

Is inheritance taxable, or do you have to pay taxes on an inheritance? The short answer is: YES. Your inheritance is taxable in two ways: estate tax and inheritance tax. But, you're only required to pay inheritance tax. An estate tax is taxed before the estate is divided or distributed.

There's no federal inheritance tax, so if you'll have to pay tax, it depends on the state the deceased lived in. Here are the ranges for each of six states that levy an inheritance tax:  

  1. Kentucky (0-16%)
  2. Iowa (0-15%)
  3. Nebraska (1-18%)
  4. Maryland (0-10%)
  5. Pennsylvania (0-15%)
  6. New Jersey (0-16%)

Even if you live in these states, but the deceased didn't, you won't have to pay inheritance tax. However, state regulations and laws are subject to change, so be sure to double-check with your state tax agencies.

  1. Does inheritance count as income, or is inherited money taxable? Inheritance isn't considered income, but some inherited assets might have tax implications. 
  2. Do I have to declare an inheritance on my tax return? No, inheritances aren't regarded as income for federal tax income. But, you're obliged to pay tax whenever you take distributions from an inherited account or when you sell inherited stocks or real estate.

How much can you inherit without paying taxes?tax professional talking with client at a table while sitting Do you have to pay taxes on inheritance?

The amount of non taxable inheritance is infinite. There's no income tax due to a beneficiary on the amount inherited. Inheritance taxes vary by the state, the amount inherited, and the relation of the deceased and the heir. For example, in the six states imposing an inheritance tax, the rates vary from approximately 1% to 19% of the request.

How does inheritance tax work? Do I have to declare an inheritance in my tax return?

Inheritance tax is only applicable in the above six states. You would not pay an inheritance tax if the deceased lived in a state that doesn't levy the tax. Plus, you can't pay inheritance tax until the deceased's estate is divided and distributed to the heirs. Unlike estate tax—collected from the deceased's estate before it's given to heirs—inheritance tax is taxed after distribution. As a beneficiary, you're responsible for paying inheritance tax. Each beneficiary might pay a different amount. This amount depends on the total inheritance received and the deceased's state.

How to avoid paying inheritance tax

If you live in a state that levies an inheritance tax, there're many ways you can minimize or even avoid inheritance tax for an heir:

  • Relocate to a state before you die.
  • Pass on inheritance through an irrevocable trust.
  • Give assets away before you die.
  • Leave your estate to your spouse.

The simplest way to avoid your beneficiaries from paying inheritance tax is by leaving your estate to an exempt individual. A surviving spouse is exempted from inheritance tax, but you might need to leave them your estate for them to receive the exemption. If you live in a state where the beneficiaries are exempted, naming them as heirs should also work.

inheritance tax paper with will on table with calculator and pen Minimize inheritance tax through a trust

Another way to avoid paying inheritance tax is setting up an irrevocable tax. A trust is a legal entity from the individual who creates it, and it allows you to move an asset from your possession into the trust. This decreases the amount taxed on the assets, too.

But, an irrevocable tax helps with inheritance tax if the individual who creates it no longer has control over it. They can't have the right to change heirs or receive income from the trust. With that, a revocable trust might not help your heir avoid inheritance tax.

Minimize inheritance tax through gifts

The most common way to avoid inheritance tax is to gift the asset during your lifetime. The federal government and some states let you gift thousands of dollars worth of properties without having to pay taxes. 

For example, at the federal government, you might make an annual gift worth up to $16,000 in 2022 without paying any gift tax. Even if your gift is worth more than your annual limit, you don't have to pay gift tax unless you've exceeded your lifetime exemption, which is equal to estate tax exemption. 

Work with a tax professional

An expert tax professional, such as our team, can help you find out the best course of action for minimizing your tax bill to ensure that you maximize the inheritances passed on to your heirs. 

Tips for spending your inheritance wisely

  • Find out the areas where you require the most help

Owe many debts? Use your inheritance to clear that. Behind on your retirement savings? Add the fund to your retirement savings account.  

  • Think before spending

As tempting as a shopping spree might be when you immediately get a big chunk of change, rethink before spending. Put your money into a savings or money market account as you decide how you'll use it. 

  • Ask for help

From finding out if or not you owe inheritance tax to deciding how to spend your inheritances, you've got a lot to think about. If you require assistance and guidance, we encourage you to contact our team


Related: Tax Preparation Tips for High Net Worth Individuals

Tags: Tax Preparation

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