The federal government doesn’t impose a tax on property you inherit from an estate. However, some states do impose the tax when you inherit tangible or intangible property that is located within the state. As of 2011, Indiana, Iowa, Kentucky, Maryland, Nebraska, New Jersey, Pennsylvania and Tennessee are the only states that require the filing of an inheritance tax return. However, as a result of the various exemptions each state provides, there are many ways to avoid paying taxes on your inheritance.
Determine the state where the property is located. If you inherit tangible property, such as real estate, you can avoid paying inheritance taxes if the state where the property is located doesn’t impose an inheritance tax. Moreover, for intangible property, such as bank accounts, the defining factor is the state where the decedent resides prior to their death. (See Reference 1)
Assess whether your relationship to the decedent exempts you from the inheritance tax. Some states, such as Maryland, provide an exemption from the inheritance tax if you are the decedent’s child, grandchild, spouse, sibling, parent, stepparent or stepchild. The state of New Jersey, on the other hand, only allows an exemption for parents, grandparents, spouses, children, stepchildren and civil union and domestic partners of the decedent. (See Reference 2 and Reference 3, pgs. 1 and 4)
Investigate whether the value of your inheritance is below the state’s threshold. State inheritance tax laws commonly provide an alternative exemption when the value of your inheritance is below the taxable threshold, such as in Iowa where all inheritances from an estate with a total value less than $25,000 are exempt. Another example is New Jersey, which exempts the first $25,000 of your inheritance if you are a sibling of the decedent, married to one of the decedent’s children or are the civil union partner to one of their children. (See Reference 1 and Reference 3, pgs. 1 and 4)
Determine whether the state offers exemptions on specific types of property. Some states look to the source of the property you inherit to determine whether inheritance tax applies. In New Jersey, the state exempts from tax all amounts of your inheritance that relates to compensation for the wrongful death of the decedent under the New Jersey Death Act. (See Reference 3, pg. 1)
- In the event the decedent provides you with notice of your prospective inheritance before their death, it can be beneficial for you and the decedent to investigate whether gifting some of property instead of transferring it by will can minimize the potential inheritance taxes you will pay.
- It is important to remember that your obligation to file a state inheritance tax return doesn’t relate to your state of residency. Failure to file an inheritance tax return and pay the appropriate amount of tax can result in interest and penalty charges.
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