Posted November 3, 2023 by Katherine Fox.

What Federal and State Taxes do Beneficiaries Pay on Inherited Wealth?

Beneficiaries may encounter five taxes as part of the estate settlement and inheritance process:

Federal Estate Tax
State Estate Tax
State Inheritance Tax
Income Tax
Capital Gains Tax

Do beneficiaries pay Federal Estate Tax on inherited wealth?

Paying estate tax is the responsibility of the estate itself, not inheritors and heirs. Depending on the assets that make up the estate, the estate executor or administrator may have to sell assets to generate cash to pay estate taxes, or there may be cash on hand to pay the IRS.

What is the 2024 Federal Estate Tax Rate?

In 2024, Federal estate tax applies to individuals who die with estates larger than $13.61 million. Estates are taxed on their value above this $13.61 million threshold - a $16 million dollar estate may have $2.39 million subject to estate tax. The Federal estate tax rate spans from 18% on amounts from $0-$10,000 to 40% on amounts above $1 Million.

Estates with an estate tax obligation must file an estate tax return (IRS Form 706) and pay the taxes due within 1 year of the deceased person’s date of death.

The 12+ states that have estate taxes in 2024

In 2024, 12 states and the District of Columbia have an estate tax:

2024 Washington State Estate Tax

In Washington State, estate tax is due on estates over $2.19 million.

Washington State’s estate tax rate ranges from 10-20%.

2024 Oregon Estate Tax

In Oregon, estate tax is due on estates over $1 million.

Oregon’s estate tax rate ranges from 10-16%.

Everything Inheritors Need to Know about paying Taxes on an Inheritance:

Blog

The New IRA Inheritance Rules: A Millennial Nightmare

What to do with inheritance: a step-by-step guide

2024 Minnesota Estate Tax

In Minnesota, estate tax is due on estates over $3 million.

Minnesota’s estate tax rate ranges from 13-16%.

2024 Illinois Estate Tax

In Illinois, estate tax is due on estates over $4 million.

Illinois’ estate tax rate ranges from .8-16%.

*Maryland is the only state to have both an estate tax and an inheritance tax

2024 Hawaii Estate Tax

In Hawaii, estate tax is due on estates over $5.49 million.

Hawaii’s estate tax rate ranges from 10-20%.

2024 District of Columbia Estate Tax

In D.C., estate tax is due on estates over $4.71 million.

D.C.’s estate tax rate ranges from 11.2-16%.

Is state estate tax due if I didn’t live in that state?

State estate taxes are levied on any assets held within that state, regardless of where the person who died lived.

Consider a person who lives in Connecticut and has an $8 million dollar estate, $2 million of which is held in a beach house in Oregon. This person may think they won’t have to pay any estate tax, because they are under both the $12.92 million Federal estate tax threshold and the $9.1 million threshold in Connecticut. However, the $2 million house in Oregon will be subject to Oregon estate tax on the $1 million in value that exceeds the $1 million Oregon estate tax threshold.

Those inheriting from large estates, especially those with high-value real estate holdings spread across the country, could be responsible for paying Federal estate tax along with estate tax in multiple states.

The 6 states with inheritance taxes in 2024

In 2024, 6 states have an inheritance tax:

2024 Nebraska Inheritance Tax

Nebraska’s Inheritance Tax rate ranges from 0-18%

2024 Iowa Inheritance Tax

Iowa’s Inheritance Tax rate ranges from 0-10%

2024 Kentucky Inheritance Tax

Kentucky’s Inheritance Tax rate ranges from 0-16%

2024 Pennsylvania Inheritance Tax

Pennsylvania’s Inheritance Tax rate ranges from 0-15%

2024 New Jersey Inheritance Tax

New Jersey’s Inheritance Tax rate ranges from 0-16%

2024 Maryland Inheritance Tax*

Maryland’s Inheritance Tax rate ranges from 0-10%

*Maryland is the only state with both an estate and an inheritance tax.

Unlike estate taxes, inheritance taxes are paid by people who inherit wealth from an estate. Like estate taxes, inheritance taxes are due based on the location where the deceased person lived as well as where they held real estate. Inheritance taxes are not levied based on the location where inheritors themselves live.

For example, heirs of a deceased person who lived in Maryland and had real estate located in New Jersey may be subject to both estate and inheritance taxes in Maryland as well as inheritance taxes in New Jersey.

State laws on inheritance taxes vary but generally the amount paid will depend on (1) the total value of the estate inherited and (2) your relationship to the deceased person. For example, in many states lineal descendants (children and grandchildren) of a deceased person pay lower or no inheritance tax than inheritors with more distant relationships.

When is income tax due during an estate settlement or as part of an inheritance?

There are two primary instances when an estate or inheritors will have to pay income tax:

When an estate has assets that are generating income
When heirs inherit a traditional IRA or other taxable retirement account

When do inheritors need to pay income taxes during the estate settlement?

Estates that hold income generating assets, including dividend stocks, taxable bond yields, or rental real estate, will be required to file IRS Form 1041, U.S. Income Tax Return for Estates and Trusts, and pay taxes on all income. Often, this income flows through to beneficiaries’ individual income tax returns through form K-1.

Income received to an estate is taxed at the same level as individual income, but the brackets for trusts and estates are much smaller than they are for individuals. This generally results in a higher effective tax rate - estates will pay the highest Federal estate income tax rate of 37% on any income over $14,450.

When do inheritors need to pay income taxes after inheriting money?

Heirs and inheritors who inherit a traditional IRA or other taxable retirement account may have a significant tax problem upon inheritance.

After the passage of the SECURE Act in 2020, most beneficiaries of retirement accounts will be required to withdraw the full value of the account over a 10-year period. All these withdrawals are taxable income to beneficiaries.

Consider an individual who makes $200,000/year and inherits a $2 million dollar IRA. In the simplest, lowest tax case this person will withdraw 10%, or $200,000, from the account every year in order to hopefully zero it out in year 10. This additional $200,000 in income may result in an additional ~$70,000 of Federal income tax every year, significantly reducing this individual’s total inheritance. This does not account for individuals who live in states with their own income taxes, which will further reduce the total inheritance.

When do inheritors need to pay capital gains tax?

Inheritors from most estates will not be responsible for paying capital gains tax if they sell an asset immediately after it is inherited. This is because many inherited assets receive a step-up in basis, allowing heirs to sell them without incurring capital gains tax.

A "step-up in basis" refers to a tax benefit that can occur when someone inherits an asset, such as real estate, stocks, or other investments, from a deceased individual.

What is the step-up in basis?

Here’s how it works:

Original Basis: The basis of an asset is typically its original purchase price + the value of any significant improvements or reinvestments. For example, if someone bought a house for $2,000,000, that is the original basis for the property.

Inherited Asset: When an individual inherits an asset, the tax code allows for a "step-up" in the basis of that asset to its fair market value (FMV) at the time of the original owner's death. This means that for tax purposes, the beneficiary's starting point for measuring capital gains or losses is the asset's value on the date of the original owner's death, not the original purchase price.

Capital Gains Tax Implications: If the beneficiary sells the asset immediately after inheriting it, there will usually be little to no capital gains tax due.

If the beneficiary later sells the inherited asset, the capital gains tax is calculated based on the difference between the sale price and the stepped-up basis. This can result in significant tax savings, as any appreciation in the asset's value during the original owner's lifetime is not subject to capital gains tax.

For example: you inherit a house that was originally purchased for $2,000,000. Its fair market value at the time when your loved one died and you inherited it was $3,000,000. If you later sell the house for $3,200,000, you would only pay capital gains tax on the $200,000 increase in value from the stepped-up basis of $3,000,000, rather than on the entire $1,200,000 increase from the original purchase price of $2,000,000.

The step-up in basis is a valuable tax benefit for beneficiaries because it minimizes the potential capital gains tax liability on inherited assets.

The step-up in basis applies to assets inherited through a will, through intestate succession (when there's no will), or certain types of trusts. It does not apply to gifts of assets made before the original owner's death or to assets inherited through irrevocable trusts.

Let’s take the next step together

Understanding how your inheritance will be taxed is not easy. Beneficiaries can encounter a wide variety of different situations requiring knowledge and finesse to manage. If you need more help, you can download The 20 Inheritance Terms you Need to Know, or reach out to Katherine Fox, CFP® and CAP®, a financial planner for inheritors to learn how Sunnybranch can help you build a plan to manage the tax consequences of your inheritance.

What Federal and State Taxes do Beneficiaries Pay on Inherited Wealth?