What Is Inheritance Tax … and Is It Different from Estate Tax?

Will I pay taxes on my inheritance is a question that sounds like it should have a clear-cut yes or no answer, but that answer is contingent on a few factors. We’re going to review those factors to help you get a better idea of if you’ll need to pay taxes on your inheritance (and, if yes, how much). However, to truly have clarity on the situation surrounding your inheritance, you need to have an estate plan as a part of your comprehensive financial plan. We’ll explain the importance of that as well to clear the air about whether you’ll pay taxes on your inheritance.

First, we need to define what inheritance tax so that you understand exactly what you’ll be paying, if you need to pay it. Inheritance tax can oftentimes be confused with estate tax, but they aren’t one in the same. Inheritance taxes are imposed on assets that you inherit from someone who has died. Estate taxes, on the other hand, are imposed on the transfer of a deceased person’s estate. The key difference is that inheritance tax is paid by the beneficiary who inherits the deceased person’s assets whereas estate tax is paid by the deceased person’s estate.

What States Require You to Pay Inheritance or Estate Taxes?

Inheritance Taxes

Most Americans aren’t subject to paying inheritance taxes since there isn’t a federal inheritance tax. It’s also important to note that inheritance taxes are levied in the state that the deceased person lived in. So, even if your home state imposes them, you won’t need to pay inheritance taxes if you’re inheriting assets from someone in a state that doesn’t levy them. Here are the six states that enforce inheritance taxes and the ranges of their inheritance tax rates in 2023.

Iowa: 2%-6%
Kentucky: 4%-16%
Maryland: 10%
Nebraska: 1%-15%
New Jersey: 11%-16%
Pennsylvania: 4.5%-16%

Estate Taxes

Now, let’s shift gears to estate taxes. There’s only a federal estate tax for those that exceed the exemption limit of $12.92 million ($25.84 million for married couples) in 2023. Did you know that it was only $5.49 million ($9.98 million for married couples) back in 2017? So, why the substantial change? The Tax Cuts and Jobs Act increased the exemption level in 2018. If you read one of our articles from a year ago, though, you’re aware that the Tax Cuts and Jobs Act is scheduled to sunset on January 1, 2026. That would cut the estate tax exemption level back in half.

While the federal estate tax only impacts the ultra-wealthy, there are 12 states that levy estate taxes. The District of Columbia does as well. Let’s review them and their rates in 2023.

Connecticut: 11.6% or 12%
Washington, D.C.: 11.2%-16%
Hawaii: 10%-20%
Illinois: 0.8%-16%
Maine: 8%-12%
Maryland: 0.8%-16%
Massachusetts: 0.8%-16%
Minnesota: 13%-16%
New York: 3.06%-16%
Oregon: 10%-16%
Rhode Island: 0.8%-16%
Vermont: 16%

You’ll notice that Maryland is the only state to have an inheritance and estate tax. But even if you’re not a beneficiary of a deceased person who lives in a state that levies an inheritance tax or you live in a state that imposes an estate tax, that can quickly change. So, make sure you’re staying up to date on the rules of specific states so you’ll know whether you’ll be paying taxes on your inheritance.

Do You Know What You’re Inheriting?

Before you ask yourself if you’ll be paying taxes on your inheritance, ask yourself when was the last time that you reviewed your estate plan. And if you don’t have an estate plan, that’s where you need to start. Do you know what you’re inheriting and do your loved ones know what they would inherit from you whenever you pass on? It’s critical to be transparent with your beneficiaries (and that your heirs are transparent with you) when it comes estate planning.

Paying taxes on your inheritance isn’t ideal in the first place. But it’s even more unpleasant if you aren’t planning for them. So, if you haven’t reviewed your estate plan this year, be sure to do so—especially if you know your beneficiary situation has changed or will soon be changing. If you’re not comfortable talking to your loved ones about inheritance (or vice versa), consider getting the whole family together each year to have family estate planning meetings as a part of family vacations. A nice change of scenery with your loved ones all around you can make those hard conversations a little easier.

The Bottom Line

Figuring out if you need to pay taxes on your inheritance highlights how critical it is to work with a team of financial professionals. At Modern Wealth, our financial planning process begins with you outlining what’s important to you and your spouse during a meeting with one of our CFP® Professionals. That’s vital to building a goals-based financial plan that can help give you more confidence, freedom, and time in retirement.

Once your plan has been built, one of our CPAs will review your plan to see what tax planning opportunities are available to you. For example, when it comes to paying taxes on your inheritance, did you know that life insurance proceeds generally come to the beneficiary tax-free if properly structured? If that sounds compelling to you, that’s one of many reasons why you should be working with a CFP® Professional that works alongside a CPA.

And, of course, it’s important to discuss whether you’ll pay taxes on your inheritance with an estate planning specialist. We also have estate planning specialists in house. So, if you have any questions, you can schedule a 20-minute “ask anything” session or complimentary consultation with one of our CFP® Professionals, CPAs, or estate planning specialists. You can meet with us in person, by phone, or virtually.

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Investment advisory services offered through Modern Wealth Management, LLC, an SEC Registered Investment Adviser.

The views expressed represent the opinion of Modern Wealth Management an SEC Registered Investment Adviser. Information provided is for illustrative purposes only and does not constitute investment, tax, or legal advice. Modern Wealth Management does not accept any liability for the use of the information discussed. Consult with a qualified financial, legal, or tax professional prior to taking any action.