Free Guide to Understanding Inheritance Tax

What Is Inheritance Tax and How Does It Work?

Inheritance tax is a state-level tax that some people pay when they receive money or property from a deceased person's estate. It's different from estate tax, though the two terms are sometimes confused. Inheritance tax is paid by the person who receives the inheritance, while estate tax is paid by the estate itself before distribution.

Understanding Pension Benefits Tax Rules Guide →

As of 2024, only six U.S. states have inheritance taxes: Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. Each state sets its own rules about who pays, how much they pay, and what types of inheritances are taxed. For example, Pennsylvania taxes inheritances at rates between 0% and 15% depending on the relationship between the deceased and the heir.

The amount of tax owed depends on several factors: the value of what you inherit, your relationship to the person who died, and the state's specific tax rates and exemptions. A spouse inheriting from another spouse typically pays no inheritance tax in most states. Adult children often pay higher rates than spouses but lower rates than unrelated individuals or distant relatives.

Understanding how inheritance tax works matters because it can affect how much money or property you actually receive. If an inheritance is worth $100,000 in a state with an inheritance tax, you might receive less after taxes are paid. The executor of the estate or the state tax authority will handle collection, but knowing the rules helps you understand what to expect.

Practical takeaway: Check which state has jurisdiction over the estate. If you live in or the deceased lived in one of the six inheritance tax states, the rules in that state will determine whether any tax applies to your inheritance.

Which States Have Inheritance Taxes and What Are Their Rules?

The six states with inheritance taxes each have different structures and exemptions. Understanding the specific rules in each state is important if you may inherit in one of these states or have property there.

Free Guide to Understanding Financial Hardship Programs →

Iowa taxes inheritances at rates from 1% to 16% depending on the relationship to the deceased. Spouses, children under 21, and parents are exempt. Grandchildren pay lower rates than more distant relatives. The exemption amounts vary: children have a $40,000 exemption, while grandchildren have $10,000.

Kentucky taxes inheritances at 4% to 16% based on the relationship and value. Spouses and direct descendants (children, grandchildren) are completely exempt. Siblings pay lower rates than more distant relatives. The state offers exemptions starting at $1,000 to $30,000 depending on the relationship category.

Maryland imposes inheritance tax at 0% to 10%, but spouses, children, grandchildren, and parents of the deceased are exempt. Only siblings, aunts, uncles, and unrelated individuals pay the tax. This is one of the most restrictive inheritance tax structures because most family relationships avoid taxation entirely.

Nebraska taxes inheritances at 1% to 18% depending on the relationship. Spouses are completely exempt. Children and grandchildren have exemptions of $40,000, while siblings have $15,000 exemptions. More distant relatives pay higher rates with lower exemptions.

New Jersey applies inheritance tax at 0% to 16%, with spouses completely exempt. Children, grandchildren, parents, and grandparents are also exempt if they meet certain conditions. Siblings pay 12% to 14.5%, while unrelated individuals and more distant relatives face the highest rates.

Pennsylvania taxes inheritances at 0% to 15%. Spouses, parents, and direct descendants (children and grandchildren) are completely exempt. Siblings pay 12%, while other relatives and unrelated individuals pay higher rates.

Practical takeaway: Direct family relationships—spouses, children, grandchildren, and parents—are exempt or face the lowest rates in every state with inheritance tax. If you're inheriting from a parent or grandparent, you likely won't owe inheritance tax regardless of the amount.

Exemptions and Deductions That May Reduce or Eliminate Tax

Exemptions are the primary way inheritance tax is reduced or avoided. An exemption is a dollar amount that is not subject to tax. Each state sets different exemption levels based on the relationship between the deceased and the heir.

Free Guide: Missouri Property Tax Credit Information and Income Limits →

In most inheritance tax states, the closer the family relationship, the higher the exemption. For example, if a state offers a $40,000 exemption for children and you inherit $60,000, only $20,000 would be subject to tax. If the inheritance is below the exemption amount, no tax is owed.

Some states distinguish between exempt and taxable heirs differently. Maryland's approach is broad: spouses, lineal descendants (children, grandchildren), and lineal ascendants (parents, grandparents) are completely exempt—meaning zero inheritance tax on any amount. This means if you inherit from your parent in Maryland, no matter whether it's $10,000 or $1 million, no state inheritance tax applies.

Nebraska and Iowa offer smaller exemptions but still provide meaningful relief. A child inheriting $30,000 in Nebraska would owe no tax if the exemption is $40,000. However, if the inheritance is $60,000, the tax would apply only to the $20,000 above the exemption.

Some states offer deductions separate from exemptions. A deduction reduces the taxable amount after the exemption is applied. For instance, Nebraska allows deductions for final medical expenses and debts of the estate in certain circumstances.

Portability rules in some states also matter. If one spouse dies and leaves everything to the other, most states exempt this transfer entirely. However, if the surviving spouse later remarries and passes the inherited assets to a new spouse, different rules may apply.

Practical takeaway: Before assuming you'll owe inheritance tax, calculate the inheritance amount and compare it to the exemption for your relationship category in the relevant state. Many inheritances fall below exemption thresholds and generate no tax liability.

How Inheritance Tax Is Calculated and What You Actually Owe

Calculating inheritance tax requires knowing three pieces of information: the value of the inheritance you receive, your relationship to the deceased person, and the tax rate and exemption amount in the relevant state.

Free Guide to Navy Federal Credit Union Basics →

Here's a practical example: Suppose you inherit $75,000 from your sibling in Nebraska. Nebraska taxes siblings at rates between 13% and 15%, and provides a $15,000 exemption for siblings. The calculation would be: $75,000 minus $15,000 exemption equals $60,000 taxable amount. At a 15% rate, the tax would be $9,000. You would receive $66,000 after the inheritance tax is paid.

Another example: You inherit $100,000 from your parent in Pennsylvania. Pennsylvania completely exempts direct descendants from inheritance tax. Even though $100,000 is a substantial inheritance, you owe zero state inheritance tax because parents are exempt from all inheritance tax in that state.

The calculation becomes more complex when the inheritance includes property rather than just cash. Real estate, vehicles, stocks, and other assets must be valued as of the date of death. The executor of the estate typically obtains professional appraisals for real estate and valuable personal property. The appraised value becomes the basis for tax calculation.

Some inheritances include multiple types of assets. If you inherit a house, a car, and a bank account, each asset is valued separately, and the total value determines the inheritance tax. The executor's job includes calculating the total estate value and determining which portions are subject to tax based on state law.

The person responsible for paying the inheritance tax depends on the state and the estate's structure. Usually, the executor of the estate pays the tax from the estate's assets before distributing remaining funds and property to heirs. However, in some situations, the heir is responsible for paying the tax directly to the state.

Tax rates vary by relationship and sometimes by the inheritance amount. States often use brackets similar to income tax, where larger inheritances face higher percentages. For instance, Iowa's tax rate for grandchildren starts at 10% for amounts under $25,000 and increases to 16% for amounts over $100,000.

Practical takeaway