“The death of a loved one is always a difficult time. The last thing most people want when they're grieving is to have to deal with the IRS and state tax officials.”
Unfortunately, unless the person you love has an estate plan and has spoken with you about it, the time you are grieving will also be the time you have to get up to speed about both death and taxes. The tax questions are explored in an article from the Delaware Bulletin Review titled “What Taxes Do You Have to Pay on an Inheritance?”
First, there is no federal estate tax on property. Federal law does not impose inheritance taxes on the heir directly. This is similar to gifts, as gift recipients don’t pay federal gift taxes either. However, that does not mean heirs don’t pay taxes. It is actually the opposite. That’s why it’s good to have these conversations before a loved one passes.
Estate taxes apply at the federal level, and they are paid by the estate. The executor uses cash from the estate or sells estate assets to pay the tax.
Unless there is specific language in the will or trust staying otherwise, federal estate tax liability does not usually impact specific bequests of cash or property to beneficiaries. The heirs may receive less of an inheritance because taxes are being paid by the estate. As of this writing, the federal tax exemption is very high--$11.7 million—so very few Americans actually pay federal estate tax.
However, exemptions on state estate taxes are considerably lower. Some states also have inheritance taxes, which are paid by heirs, usually out of their inheritances.
Note: if the estate fails to pay any estate taxes, the IRS is empowered to collect taxes from heirs.
Six states have inheritance taxes. If you are a resident of Iowa, Kentucky, Maryland, Nebraska, New Jersey, or Pennsylvania and expect to receive an inheritance, be mindful that there will be taxes taken from your inheritance. Each state has its own rules, so work with a local estate planning attorney to be certain that you are paying the correct amount to the correct governmental taxing agency.
There is no way for an heir to prevent this tax liability. The only person who can have an impact on inheritance taxes is for the person who is leaving the bequest to plan in advance for the taxes. This is usually done through the use of a trust or gifting while they are still living. Some states have rules that frown on gifting assets immediately before death. If gifts are given regularly for a number of years in advance of the death, they are less likely to be considered as being given “in contemplation of death” and, therefore, potentially subject to estate tax.
An experienced estate planning attorney will know the inheritance, federal estate and gift tax rules and can help guide the family, pre- and post-mortem, in managing the tax liabilities of an inheritance. If your aging parents live in one state and you live in another, you may owe estate taxes in their state and inheritance taxes in your state.
Reference: Delaware Bulletin Review (Jan. 19, 2021) “What Taxes Do You Have to Pay on an Inheritance?”