What is an Inheritance Tax?

An inheritance tax is levied on a beneficiary who inherits assets from a deceased person. Unlike an estate tax, in which the estate bears the tax burden, an inheritance tax must be paid by the beneficiary.¹

How is inheritance tax determined?

In many countries, no inheritance tax is levied on the person to whom the property is transferred. However, this is not true in all cases. Some countries set a limit on the value to which no tax is charged. The value of the inheritance is also determined based on the existing market value. In some cases, the tax amount is established based on the value after a certain amount of time has passed since the estate holder's death.

In the US, only six states impose inheritance taxes – Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania.² However, these taxes are set by each state and may differ depending on where you live.

The amount of tax also varies based on the inheritor’s relationship to the deceased person. For example, in the US, spouses are automatically exempt from inheritance taxes.³ In most cases, children and spouses do not have to pay any inheritance tax, but it depends on the jurisdiction in which the inheritance is received.

Example

Mr. James has assets worth $10 million to be distributed equally between his son Davies and his nephew Russel. If the state provides an exemption of $1 million for lineal descendants, then Davies would only have to pay a tax on $4 million out of the total assets worth $5 million that he received. On the other hand, Russel would have to pay tax on the entire $5 million. Additionally, if the rate is 4% for Davies and 5% for Russel, Davies must pay a tax worth 4% of $4 million or $0.16 million, whereas Russel owes $0.25 million in inheritance tax.

References

1. “What is an Inheritance Tax?” Investopedia. https://www.investopedia.com/terms/i/inheritancetax.asp

2. “17 States With Estate or Inheritance Taxes.” AARP. https://www.aarp.org/money/taxes/info-2020/states-with-estate-inheritance-taxes.html

3. “All About the Inheritance Tax.” Smart Asset. https://smartasset.com/taxes/all-about-the-inheritance-tax

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