Do You Have to Pay Taxes on Your Inheritance?

I had a client from Nebraska whose wife received an inheritance from her father who lived in New Mexico and wanted to know if they had to pay taxes on the inheritance (inheritance tax).

When someone dies and leaves an inheritance to the living members it may trigger these two types of tax consequences. These are two terms that are part of the same event but depends on what side of the event each person is positioned in.

1.     Estate tax

2.     Inheritance tax

The trigger on both taxes really depends on multiple variables. We will review both at a generic and high level because the purpose of this article is to be able to identify and recognize each of the two types.

Estate Tax

This applies to the person who has died or better said, to his/her assets, properly called estate. We will call “estate” to the gross assets (cash, collectibles, furniture, real estate property, bonds, stock, mortgages, notes, etc.) that belonged to the person who has died and the fair market value is used for valuation purposes. For 2019, there is no estate tax if the value of the estate is of less than $11.4 million and no estate tax return needs to be filed. However, if the estate’s value is greater than $11.4 million, an estate tax return is prepared, and appropriate taxes are paid.

Inheritance Tax

This applies to the person receiving the inheritance. It is important to mention that there is no inheritance tax at the federal level. However, there are a few states that do have an inheritance tax. The states that have an inheritance tax are Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. This means that the people who receive an inheritance from someone who lived in these states or if property located in any of these states that is part of the estate, would be subject to the inheritance tax.

To make this theory useful, let’s look at my client’s question. His father in law lived in New Mexico. My client and his wife, who received the inheritance, live in Nebraska, a state with inheritance tax. Are they subject to the inheritance tax? No, they are not subject to the inheritance tax because the deceased person lived in New Mexico, a state with no inheritance tax and there was no property located in Nebraska.

Conclusion

What drives the rules of the inheritance tax is the where the decedent lived or owned property, not where the inheritance recipient lives.

My client’s wife would not be subject to the inheritance tax because her father lived in New Mexico, a state that has no inheritance tax and no physical property was in Nebraska. Based on what we know now, consider where you live and imagine you receive an inheritance from someone who lives in Pennsylvania, does the inheritance tax apply to you? Why?

What is this telling us at a different level?

People who plan to leave large estates when they die may decide to avoid residing or owning significant property located in these states. This is a very generic statement because we didn’t even look at the tax rate for each of those states or other factors and the always present “exceptions” to the inheritance tax but that would be the net effect I can see where tax policies may affect human behavior. Below is a map of the states that have an estate and/or inheritance tax, which may be triggered at different values of the estate.

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Jose Garcia