Losing someone close to you is always difficult. But the whole situation can become even harder when there is some money and lots of paperwork involved. Depending on the state you live in and inherit in, when you’re a beneficiary to the deceased’s will, you may be liable for an inheritance tax (often mistaken with an estate tax or a capital gains tax). And though you’re never left on your own, and there are companies like Probate Advance that can help you by providing either or both advice and money, it’s best to know as much as you can on the topic. 

Inheritance tax vs. other taxes

Inheritance tax is a tax required by the law of a state; it’s not something imposed on a federal level that doesn’t even recognize it as income. There are states, however, that require you to pay a tax when you inherit something. These states are Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. Still, none of these states require a tax if you inherit something from your spouse, and only Nebraska and Pennsylvania tax assets inherited by children and grandchildren. What’s more, even if you live in any of these states, but the deceased lived in any of the remaining, you don’t have to pay. These taxes vary from 1% to even 20%, so if you happen to inherit something, look for all the necessary information at your state’s tax agency.

And to not confuse inheritance tax with other taxes, here’s a short description of what estate and capital gains taxes are:

• Estate tax

This is a tax that has to be paid if the estate included in the will is of more than $11.4 million from the tax (2019) and $11.58 million (2020). Plus, it’s not actually paid by the beneficiary, but by the estate, so it may only lower its value; it doesn’t affect your pocket. That’s how it is on the federal level, but it may vary in various states. For example, in Massachusetts, estates worth more than $1 million can be taxed. 

• Capital gains tax

This is the difference between the real value of an inherited item and the amount that you sell it for. If you sell it for less, nothing happens, but if you sell it for more than it’s worth, then you will have to pay a tax from your gain. 

It’s also important to know that your inheritance is what you get after estate tax, and other necessary commitments have already been paid. So you don’t have to pay inheritance tax for the whole estate, but for what you get in the end. 

Inheritance taxes and income taxes

Inheritance is not considered as income by the state nor by the federal government, so you don’t have to report it while doing your income taxes. However, some properties may have other income tax consequences (IRA or 401(k), so it’s better to consult with a professional to know everything.

You need to remember to file a state tax form whenever you inherit money, estate, investments, cash, or any other assets. Otherwise, you risk penalties and interests. 

How does inheritance tax work?

Every will needs its executioner to distribute all the assets. Inheritance tax has to be paid after assets have been distributed, and they are already in possession of beneficiaries. Each beneficiary has to pay it, as it’s calculated individually, not for the whole will. So, for example, a state may tax all inheritances over $1 million for 5%, and if you inherit $3 million, you will only pay 5% of exceeding $2 million, not of all $3 million. 

Is it possible to lower the inheritance tax?

Yes, but, unfortunately, it’s mostly possible for the benefactor before he or she dies, not for the beneficiary, after the benefactor has already died. That’s why it’s essential to structure the estate and name the heirs properly when it’s your will and, while it may be a little awkward, talk honestly to the people that you know you will inherit something from. 

Know your finances

Remember that every asset matters and even if your will doesn’t go to probate, it doesn’t mean you don’t have to pay, or that you will pay differently. 

It’s extremely important to educate yourself on the topic of finances. Not everyone needs to be an expert and perform splendidly on Wall Street. Still, you need to know your responsibilities and commitments, but also rights and possibilities to be able to protect yourself and your family.