Inheritance Tax: What States Have It and When It Applies

Inheritance tax is a state-level tax that beneficiaries pay when they receive assets from an estate after somebody has passed away.

The inheritance tax is distinct from estate taxes, but planning tools for avoiding or minimizing it, such as lifetime gifting and placing assets in a trust, can be used for both types of so-called “death taxes.”

A personalized strategy for managing this potential tax should account for state laws about the types of property and beneficiaries that are subject to taxation of an inheritance.

History and Status of the Inheritance Tax

There hasn’t been a federal inheritance tax since 1902. According to the Tax Foundation, the U.S. government levied an inheritance tax from 1862 to 1870 to finance the Civil War and from 1898 to 1902 to help pay for the Spanish-American War.

States began to impose an inheritance tax starting with New York in 1885. By 1916, 43 states had an inheritance tax. Only six states — Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania — have an inheritance tax in 2024, and Iowa’s is ending on January 1, 2025.

The Tax Foundation says that most states have phased out inheritance taxes because they are administratively burdensome, disincentivize business investment, and can drive high-net-worth individuals out of state.

Inheritance Tax vs. Estate Tax

Inheritance taxes and estate taxes are considered a type of “death tax.” While these taxes are levied when a person dies and leaves assets to beneficiaries, they differ in who is responsible for paying the tax.

• An estate tax is paid by the decedent’s estate before assets are distributed to beneficiaries. The tax is imposed on the overall value of the estate.
• An inheritance tax is paid by the person who receives assets from a decedent’s estate. The tax is imposed on the amount distributed to a specific beneficiary.

Like estate taxes, inheritance taxes have an exemption level. That means the value of the inherited assets must be worth more than a certain minimum amount for taxes to be owed on the inheritance.

In addition to the federal estate tax, several states have an estate tax. Just one state — Maryland — has an estate tax and an inheritance tax.

How States Tax an Inheritance

Inheritance taxes are assessed by the state (or states) where the decedent lived or owned property. If a beneficiary’s state does not have an inheritance tax rule, the tax does not apply. And if the tax does apply, it only applies to the part of an inheritance that exceeds the state’s exemption amount.

However, in most cases, the relationship of the decedent to the beneficiary, not the amount of money or property that is transferred to the beneficiary, is the major determinant in whether inheritance tax is owed. This is because spouses and other immediate family members are typically exempt from the inheritance tax.

Here is a state-by-state breakdown of inheritance tax rules:

• Iowa: Surviving spouses, parents, grandparents, great-grandparents, children, stepchildren, grandchildren, great-grandchildren, and other lineal ascendants and descendants, including adopted children, are exempt from Iowa’s inheritance tax, and charities are exempt up to $500. The tax rate for nonexempt individuals and entities is 2 percent to 6 percent of the inheritance, depending on the amount inherited.
   
• Kentucky: In Kentucky, surviving spouses, parents, children, grandchildren, brothers, sisters, half-brothers, and half-sisters of the decedent are exempt from the state’s inheritance tax. Charitable, educational, and religious institutions are exempt as well. Nieces, nephews, half-nieces and nephews, daughters and sons-in-law, aunts, uncles, and great-grandchildren have a $1,000 exemption and a tax rate of 4 percent to 16 percent.
  
  For all others, the tax rate ranges from 6 percent to 16 percent. Kentucky also charges nonexempt beneficiaries a fee on a sliding scale.
   
• Maryland: Maryland’s inheritance tax does not apply to immediate family members of the decedent, including their spouse, children, parents, grandparents, brothers, and sisters. Nonprofits, state-owned entities, and small estates valued at $50,000 or less are also exempt. A 10 percent inheritance tax is charged to nonexempt persons and organizations.
   
• Nebraska: Spouses and charities are fully exempt from Nebraska inheritance tax. Immediate relatives (parents, grandparents, children, grandchildren, brother and sisters, adopted children, etc.) have an exemption amount of $100,000 and a tax rate of 1 percent. Other relatives have a $40,000 exemption and an 11 percent rate.
  
  Everyone else has a $10,000 exemption and a 15 percent rate. Changes to Nebraska inheritance tax law took effect in 2023.
   
• New Jersey: In New Jersey, a decedent’s spouse, domestic or civil union partner, parents and grandparents, biological and adopted children, stepchildren, and grandchildren, as well as charitable organizations, are fully exempt, while siblings and sons and daughters-in-law are exempt up to $25,000. After that, the New Jersey inheritance tax rate ranges from 11 percent to 16 percent.
   
• Pennsylvania: Pennsylvania inheritance tax does not apply to the surviving spouse and minor children (21 or younger); to property transferred from the estate of a military member killed on active duty; or to tax-exempt charities, institutions, and government entities. Property jointly owned by a married couple is also exempt from inheritance tax. Nonexempt family members and organizations pay a tax on a sliding scale, from 4.5 percent to 15 percent.

Other Inheritance Tax State Rules

Exemptions and taxation rates are the main rules to be aware of in the six states that impose an inheritance tax. Other rules come into play when this tax is owed; however, they vary from state to state. These rules include:

• Property subject to inheritance tax: Inheritance tax is generally levied on property, investments, and money left to heirs, but each state provides a detailed list of the assets subject to inheritance tax. Some states have what are known as “clawbacks” or “deathbed gifts” that are added back to the decedent’s estate when they pass away.
  
  Nebraska, for example, taxes property that the deceased person gave away or transferred for below market value within the three years preceding their date of death. Certain types of property, such as life insurance not payable to the estate, may be exempt.
   
• Inheritance tax return and filing deadline: A nonexempt beneficiary must pay the inheritance tax using a special tax return form that is available from the decedent’s state of residence. A beneficiary must submit the tax return and pay the tax by the state-specified deadline.
  
  For example, this deadline is nine months in Iowa, 12 months in Nebraska, and 18 months in Kentucky, which allows a 5 percent discount if the inheritance tax is paid within nine months. It may be possible to request an extension for filing the return and making payment.
   
• Asset valuation: Inheritance tax is levied based on the fair market value of the decedent’s property at the date of death. The administrator of an estate, who works with valuation experts like a tax assessor and a real estate agent, is typically responsible for valuing estate assets.

States can charge penalties and interest on late payments when an extension has not been granted. They might also conduct an audit of the inheritance tax return and determine that additional tax is due. A beneficiary could end up owing capital gains tax on an inherited asset if they choose to sell it.

Beneficiaries subject to the inheritance tax may want to consult with an attorney or a tax professional in the state where the decedent lived to make sure they are complying with all applicable tax laws.

Planning for the Inheritance Tax

Due to exemptions and the fact that inheritance tax is levied in only six states, few beneficiaries (around 2 percent) will end up owing a tax on inherited assets. That is still more than the number of estates (an estimated 0.2 percent) that end up paying the federal estate tax, which has a high exemption level.

For those fortunate enough to receive an inheritance — but unfortunate enough to owe inheritance tax — the resulting tax burden can be significant.

Inheritance tax mitigation strategies can be incorporated into an estate plan if a person lives or owns property in one of the states that charges this tax and plans on leaving assets to a nonexempt heir.

Moving to one of the many states that does not have an inheritance tax is the most obvious, although probably not the most practical, solution. Other strategies include:

• Using the federal annual gift tax exclusion ($18,000 per person/$36,000 per couple in 2024) to help offset the inheritance tax, with the caveat that a state may have a clawback provision for gifts made within two or three years of the giver’s death.
• Setting aside assets in an irrevocable trust for beneficiaries subject to this type of tax.
• Buying a life insurance policy equal to the amount of assets that would otherwise be left to a beneficiary and bequeath that instead of leaving the beneficiaries the assets outright. Life insurance proceeds are usually not subject to inheritance tax.
• State law may allow the estate to pay the tax on behalf of the heir. This provision can be included in the decedent’s will.

If you reside or own property in a state that collects this type of tax, discuss ways to preserve more of your wealth for your heirs with your local estate planning attorney. They will be familiar with the relevant tax rules in that state. Your attorney can also help a beneficiary subject to the inheritance tax understand their obligations and rights.