Every so often, Congress introduces bills to reduce or repeal what are known as “death taxes.” Eliminating these levies tends to create controversy; one side argues that the estates of high net-worth descendants should pay their fair share in taxes. The other side argues that such a tax is unfair to those left behind.
But, the constant attention to the federal estate tax and the less common state-driven inheritance tax leads to many questions. One such question is how much a beneficiary or heir can inherit without paying these taxes. To answer this, it’s a good idea to understand exactly what these taxes are and how much they might cost. With this information, it’s easier to introduce elimination or reduction strategies.
Defining “Death Taxes”
As can be surmised by their description, “death taxes” come into play when someone dies. Such levies are better known as the federal estate Tax. According to the IRS, it is “a tax on your right to transfer property at your death.” This levy analyzes the departed’s asset ownership, interests, and fair market values, then combines them into the “Gross Estate.” Specific deductions (such as mortgages, estate administration expenses, property passing to spouses, and charitable gifts) come into play, resulting in the “Taxable Estate.”
Some states also have their own estate taxes (in addition to the federal Estate Tax). And some states have another type of death tax known as inheritance tax. The difference?
- The departed’s estate pays estate taxes (both state and federal) before assets are distributed to heirs or beneficiaries. Seventeen states have estate taxes.
- The recipients or beneficiaries pay inheritance taxes after asset distribution. There are six states with inheritance taxes.
Here’s an interesting fact: Maryland is the only state with estate and inheritance taxes.
To Pay . . . Or Not to Pay
Because of the above, there is no one answer to the question of how much money you can inherit without paying taxes on it. It’s the same when trying to answer how much you can inherit from your parents without paying taxes or paying federal taxes. The response depends on several issues, such as the Estate Tax thresholds, where the beneficiaries or heirs live at the time of the decedent’s death, and the relationship between the two parties.
Estate Tax Thresholds
It’s important to understand that not all estates will be subject to taxes. On the federal level, the IRS sets limits—or thresholds—on estate values before taxing them. You can inherit up to $12.92 million in 2023 without paying federal estate taxes due to the estate tax exemption. However, some states have their own inheritance taxes, so you may still owe taxes to your state.
Any estate exceeding the above thresholds could be taxed up to 40%.
Furthermore, the following states levy their own estate taxes, with lower thresholds and varying percentages depending on the tax bracket.
State | Threshold Amount | Tax Percentage |
Connecticut | $12.920 million | 12% |
District of Columbia | $4.258 million | 11.2%-16% |
Hawaii | $5.490 million | 10%-20% |
Illinois | $4 million | 0.8%-16% |
Maine | $6.410 million | 8%-12% |
Maryland | $5 million | 0.8%-16% |
Massachusetts | $2 million | 0.8%-16% |
Minnesota | $3 million | 13%-16% |
New York | $6.58 million | 3.06%-16% |
Rhode Island | $1.733 million | 0.8%-16% |
Oregon | $1 million | 10%-16% |
Vermont | $5 million | 16% |
Washington | $2.193 million | 10%-20% |
Source: Tax Foundation
As such, if the departed lived in any of the above states (or DC), the threshold for estate taxes is lower than that involving federal taxes. Furthermore, double taxation could be likely if a decedent’s estate located in any of the above states exceeds a value of $12.923 million (for 2023).
Inheritance Tax Amounts
As mentioned above, inheritance taxes operate differently. These taxes are paid by beneficiaries and are calculated based on asset value and tax brackets.
The following states levy inheritance taxes:
State | Tax Percentage |
Iowa | 0%-6% |
Kentucky | 0%-16% |
Maryland | 0%-10% |
Nebraska | 1%-15% |
New Jersey | 0%-16% |
Pennsylvania | 0%-15% |
Source: Tax Foundation
Reducing or Eliminating Death Taxes
Whether such taxes are considered unfair or justified, it’s important to understand that not all estates will be subject to levies. In 2020, for example, fewer than 0.1% of estates filed the tax forms, with only 0.04% of estates actually paying federal taxes.
Additionally, the Estate Tax exemption is “portable” between spouses on both the federal and state levels. This means that spouses inheriting estates, no matter the value, will not have to pay taxes.
Finally, in states with inheritance taxes, not all beneficiaries need to pay; only distant relatives or non-related beneficiaries might be responsible for those expenses.
The best way to reduce or eliminate estate or inheritance taxes is to encourage the following:
- Transfer part, or all, of the estate to an irrevocable trust and transfer part of the estate to it
- Gift funds to family and beneficiaries before death to reduce the estate size
- Pass the entire estate to a spouse
The takeaway is that while death taxes exist, they can be mitigated and/or reduced. Planning before an individual’s death can help ensure the entire estate value can be passed to future generations with minimal loss.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.
Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.
