Inheritance Tax: The Complete Guide 2020

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Ever wonder if the IRS will come knocking if you receive an inheritance? Learn everything you need to know and more in my complete inheritance tax guide!

In this article

Key Points

  • Don’t confuse inheritance tax with estate tax 
  • Inheritance tax is a state tax levied on inherited assets
  • Estate tax is a federal tax (and sometimes state tax) levied on the transfer of assets of an entire estate
  • One of the best methods to lowering your inheritance tax is by holding a candid discussion with your CPA
  • Whether you pay inheritance tax or estate tax comes down to where you live, geographically

Inheritance Tax: The Complete Guide 2020


It’s always nice to dream about an inheritance from a long, lost relative, isn’t it? 

Before you start imagining all the possibilities that the “new” money could buy you – it’s important to consider how the government – ie the IRS – would treat your inherited money or assets

That’s right my friends, the government does keep an eye on those who have just inherited money. 

What I mean by this is that if you do come into an inheritance – there could be a possibility that you may owe some taxes. 

That’s why it’s important that you know your state and federal inheritance tax laws – there are some cases in which inheritance tax laws may apply to you, and other cases in which they may not apply to you. 

Let me tell you that from personal experience – an inheritance tax can come as an unwelcome surprise. 

I was beginning a mentorship engagement with a mentee of mine who had just received a very sizable inheritance. 

Little did she know that because she lived in a state that levies inheritance tax, she had the IRS knocking on her front door a few months after she received the inheritance. 

It was not a pleasant surprise.

To avoid any unwanted IRS surprises when it comes to your inheritance, let me show you how you can take the bull by the horns and prepare for potential tax consequences before the IRS comes knocking at your door.

What is Inheritance Tax?


Typically, only the large estates are required to pay a hefty tax (40% – at least per 2020 tax laws) on the transfer of assets via inheritances. 

So to be very honest, unless your family is a top 1% family, then the odds are that you don’t have to pay a tax on an inheritance.

However, I do think it’s important to understand the basics of an inheritance and whether you could be liable to pay a few bucks to the IRS. 

That’s because whether you pay tax on your inheritance really comes down to where you live.

To provide more context: You pay inheritance tax, on a state level, when you receive assets from someone who passed away. 

I want to make 3 clarifications: 

  • Inheritance tax is a state tax and not a federal tax
  • Not all states have an inheritance tax
  • If you receive the inheritance, you pay the tax

What States have Inheritance Tax?


Now that you’re probably scratching your head and wondering whether you live in a state that levies an inheritance tax (or possibly even an 
estate tax), I thought it might be a good idea to take a look at the chart, below.

the millennial money woman blog post "does my state have inheritance tax"
Sources: The American College of Trust and Estate Counsel.

This chart provides a great visual to add some context to who taxes the inheritances people leave to their heirs. 

Not only does the government tax inheritances but some states do as well. 

Keep in mind, this chart is based on 2020 tax laws. 

Inheritance Tax vs. Estate Tax


As I mentioned before, there is an important distinction between an inheritance tax and an estate tax. 

I’ve heard these 2 terms be thrown around very loosely and interchangeably – which is not correct. 

That’s why I want to make sure I take the time to explain the difference between the 2 terms. 

Keep in mind that the descriptions I’m about to provide you for the inheritance tax vs. the estate tax are based on 2020 tax laws. 

Tax laws can always change, so make sure you stay on top of the current year’s tax, estate and inheritance laws.

Inheritance Tax Estate Tax
Who pays?
The beneficiary (you)
The decedent (the person who died)
Federal or state tax?

State

Federal (80% of the time)
How is it determined?
  • Based on the beneficiary’s geographic location
  • Amount of the inheritance
Based on the number of assets transferred upon someone’s death
Which states?
  • Iowa
  • Kentucky
  • Maryland
  • Nebraska
  • New Jersey
  • Pennsylvania
  • Connecticut
  • D.C.
  • Hawaii
  • Illinois
  • Maine
  • Maryland
  • Massachusetts
  • Minnesota
  • New York
  • Oregon
  • Rhode Island
  • Vermont
  • Washington

Estate Tax


As you can see, an estate tax is (typically) a federal tax levied on any property that is transferred upon someone’s death. 

The estate of the person who died typically pays the estate tax. 

Will all assets be taxed that are transferred upon someone’s death?

The simple answer here is no: There is a pretty nice exemption of $11.58 million per person. 

This means that the IRS will not ask for the estate to pay taxes on any assets valued up to $11.58 million (yay!! That means more money in your pocket!).

So let’s say your parents are worth $20 million and something terrible happens to them – a car crash. Both pass away and you are the only heir to the $20 million estate. 

Will there be an estate tax? Nope!

What happens if your parents leave you an estate with $30 million?

In that case, you’ll hear the IRS looking for payment from your parents’ estate. 

That is, anything that surpasses the $23.16 million threshold (for a married couple) will be taxed at a steady 40%.

Let’s take a look at the mathematical formula for this (rather rare) scenario and see how a $30 million estate would be taxed, using the 2020 tax code:

  • Estate Size: $30 million (current fair market value)
  • Married Couple Estate Tax Exemption: $23.16 million
  • Total Estate subject to Estate Tax = $6.84 million ($30 million – $23.16 million)
  • Estate Tax: 40% flat
  • Total Taxes Owed: $2.736 ($6.84 million X 40% taxes)
  • Total Estate to be Transferred: $27.264 million
the millennial money woman blog post "how a $30 million estate would be taxed, using the 2020 tax code"
As you can see, the federal tax rate for estates exceeding the $11.58 million per person threshold can be pretty hefty – at a flat 40% rate.

However – now there are some states that ALSO tax estates. 

Typically speaking, the state estate tax thresholds are MUCH lower than the federal estate tax threshold ($11.58 million per person).

Below is a list of state estate tax exclusions.

State Exclusion Amount
Connecticut
$3.6 million
District of Columbia
$5.682 million
Hawaii
$5.49 million
Illinois
$4 million
Maine
$5.7 million
Maryland
$5 million
Massachusetts
$1 million
Minnesota
$2.7 million
New York
$5.74 million
Oregon
$1 million
Rhode Island
$1.562 million
Vermont
$2.75 million
Washington
$2.193 million

Keep in mind that if you live in one of the following states with a state estate tax, I would highly recommend holding a formal meeting with your CPA (tax professional) to understand the tax rate if your inheritance were to exceed the exclusion amount. 

Tax rates could vary based on the size of the estate, the state itself, and possibly even your annual income. 

Inheritance Tax


As you can see from the previous geographic chart provided by the American College of Trust and Estate Counsel, 6 states tax individuals who receive inheritances (this is known as the inheritance tax).

As a reminder, these 6 states carrying an inheritance tax include:

  • Iowa
  • Kentucky
  • Maryland
  • Nebraska
  • New Jersey
  • Pennsylvania

Since tax rates do vary widely, I can’t tell you specifically how much your inheritance tax will be, however, the range will be from 0% to 18%. 

Below is a chart that provides a little more detail on state inheritance tax rate ranges:

State Tax Rate
Iowa
5% to 15%
Kentucky
6% to 16%
Maryland
10%
Nebraska
1% to 18%
New Jersey
11% to 16%
Pennsylvania
4.5% to 15%

As I mentioned before – if you do find yourself in a situation where you believe you’ll be subject to inheritance tax, then it’s probably time to find yourself a tax professional.

Are there exemptions as it relates to inheritance tax laws?

  • Yes – Typically in cases where spouses or children receive inheritances, inheritances are exempted and the assets going to spouses/children will not be subjected to an inheritance tax.

What is the worst state to live in for inheritance taxes?

  • Maryland. That’s because Maryland levies not only an inheritance tax but also a state estate tax (with a $5 million exclusion threshold).

Inheritance Tax Exemptions


What determines if you actually owe an inheritance tax?

Bottom line, it’s about your lineal relationship with the decedent. 

Your relationship to descendent Will you pay inheritance tax..? …If you live in these states…
Surviving Spouse
No
  • Iowa
  • Kentucky
  • Maryland
  • Nebraska
  • New Jersey
  • Pennsylvania
Domestic partner
No
  • New Jersey
Child
No
  • Iowa
  • Kentucky
  • Maryland
  • New Jersey
Grandchild
No
  • Iowa
  • Kentucky
  • Maryland
  • New Jersey

The rule of thumb is that those beneficiaries who do not have a direct or familial relationship to the decedent will likely pay higher inheritance tax rates.

Tax rates for nieces, nephews, siblings, aunts, in-laws, etc. will vary depending on the state. 

If this is your case – it’s time to chat with a CPA.

Strategies to Lower Inheritance Tax

the millennial money woman blog post "how to Reduce Your Inheritance Tax Bill"

If you live in one of the previously mentioned states where you may have to pay a state estate tax and / or an inheritance tax – it might be time to consider some strategies to reduce your inheritance tax liability. 

Ultimately, the inheritance tax bill that you are left to pay depends on the amount of money that you will inherit – and the way that your inheritance is structured. 

Below, I’ve listed 5 simple methods to potentially reduce your inheritance tax bill:

  • Discuss with your potential benefactor
  • Gifting – cash, stocks, bonds, houses, cars, etc.
  • Gifting assets before death 
  • Prepare for the tax bill in advance
  • Talk to a CPA

1) Have a Discussion with your Potential Benefactor


As you may realize, once your benefactor passes away, his or her decisions as it relates to leaving money to heirs are irrevocable – they cannot be changed.

That’s why it might be worth talking to your relative and / or friend about how they plan to structure your inheritance and how much they plan to give you. 

Sure, it will likely be a very awkward conversation – but if you believe you will receive a sizable inheritance, then you may thank yourself later for having this conversation now, before it’s too late. 

One easy way to reduce your tax bill for a potential inheritance is possibly requesting your potential benefactor to purchase a life insurance policy on their own life – and designating you as the beneficiary. 

Why? Because a life insurance death benefit is always tax-free (at least per 2020 laws).

Of course, this conversation should be held earlier (much earlier to reduce the cost of life insurance premiums) than later in the benefactor’s life.

Related: 3 Basic Estate Planning Documents

2) Gifting 


Gifting assets encompasses so much more than just gifting cash. 

You can gift a house, a car, stocks, bonds, etc.

3) Gifting Assets Before Death


Surprisingly, most states don’t tax gifts made during a benefactor’s lifetime. 

This means that your benefactor could in fact gift assets to you during their lifetime – still, see you enjoy their gift AND not worry about a state gift tax. 

Annual Exclusion

  • Most people can gift $15,000 per year without incurring a gift tax
  • Most can gift up to $11.58 million during their lifetime without an estate tax (or inheritance tax)

The important aspect here is to hold these gifting conversations with your potential benefactor and possibly an estate planning attorney well in advance. 

This will save you, the benefactor, and the benefactor’s estate a lot of money in the long run.

4) Prepare for the Inheritance Tax Bill


If you are positive you will be receiving an inheritance and are sure you will likely pay taxes on the inheritance – it’s time to start planning and preparing for the potential bill. 

How do you prepare for the tax bill? 

Talk to a tax professional. 

They will be the ones to provide you with fairly accurate estimates as it relates to a potential future tax bill. 

Once the tax professional has come up with a possible tax bill number – it’s time to put the money aside so that you can afford the tax bill once it comes. 

If you forget to pay your inheritance tax – or if you pay it late – you’ll be subjected to penalties and interest.

5) Consult a CPA


I think I’ve said this about 10 times in this blog post already – consult a professional tax planner. 

The best of the best are known as CPA’s – Certified Public Accountants.

Of course, make sure you do your research before committing to a CPA. 

They typically charge by the hour and the best ones are not all too cheap.

Also, keep in mind that CPA’s specialize in different tax areas. 

Some specializations may include:

  • Estate tax planning
  • Income tax planning
  • Foreign tax planning
  • Partnership tax planning
  • Corporate tax planning

If you are in the situation where you think you’ll be liable to pay inheritance taxes, of course, it’s time to consult an estate tax planning CPA and/or an inheritance tax CPA.

Closing Thoughts 


If you believe you are going to receive an inheritance or if you have already been notified that you are going to receive an inheritance, it’s time to start planning several things.

  • Consider if you live in a state with inheritance tax
  • Consider your relationship to the decedent
  • Consider if you live in a state with estate tax
  • Consider if you are mentally ready to receive an inheritance
  • Make sure to consult a tax professional 

Remember – even though receiving an inheritance could mean great things as it relates to your financial picture – it also means you have to prepare yourself for the possibility that the IRS comes knocking on your door as they did with my mentee. 

To prevent any unwanted or unwelcome surprises, now is the time to start doing your research and consulting the right people to prepare in advance.

The most important question to ask yourself, however, is whether you are ready to take an inheritance and manage the money (or assets) properly. 

Plan ahead and your bank accounts will thank me later!

What is your experience as it relates to taxes and inheritances?

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Fiona Smith
Fiona Smith
The Millennial Money Woman was founded by Fiona Smith. She holds her Master of Science Degree in Personal Financial Planning and has co-founded a local non-profit community teaching financial literacy to young professionals.

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