As the old adage goes, the two things you can't avoid are death and taxes. Some cash-strapped states that are hungry for tax revenue from any source they can find it aren't afraid to combine the two by taxing transfers of property after someone dies.
It's important to distinguish between inheritance taxes and estate taxes, as they have different characteristics and often get implemented differently. Estate taxes are collected from the estate before heirs get any payouts, and so by the time you receive an inheritance, you never have to worry about any estate tax liability. Most states collect estate taxes, but only on high net-worth estates and usually only as an add-on to what federal estate tax law imposes on estates.
But the inheritance taxes discussed in this article are usually completely separate from estate taxes, and with inheritance taxes, some states put the onus on you to give up part of what you receive to pay your inheritance-tax burden. Using figures from CCH as reported by Forbes as well as state department of revenue data, let's look at six states that charge inheritance taxes.
6. New Jersey
New Jersey charges inheritance taxes that run from 11% to 16%, but it also has a relatively long list of family members who are exempt from the tax. Spouses, parents, grandparents, and descendants don't have to pay the tax, and New Jersey is one of the few states for which civil union partners and domestic partners are also exempt from inheritance tax. Siblings of the deceased person or spouses of a child or other descendant get exemptions of up to $25,000, while more remote relatives and other recipients get a $500 exemption before taxes are imposed.
Maryland imposes a 10% inheritance tax on individuals who don't qualify as exempt. Among those who are exempt include spouses, parents, grandparents, siblings, and descendants, as well as spouses of descendants. Domestic partners were added to the list of exempt recipients in mid-2009. In addition, property passing to any one person that doesn't exceed $1,000 in value isn't taxed, either.
Iowa charges an inheritance tax of between 5% and 15% to heirs who aren't exempt. Exemptions in Iowa include spouses, parents and grandparents, and children and other lineal descendants. Everyone else is subject to tax, with the rates varying depending on your relationship to the deceased. Siblings of the deceased, as well as spouses of the deceased's children, pay tax at rates between 5% and 10%. Other individuals pay between 10% and 15%, although gifts to charity are entirely exempt.
Kentucky's inheritance tax applies to everyone except spouses, parents, children, grandchildren, and siblings. For certain close relatives, including aunts, uncles, nieces, nephews, and daughters-in-law and sons-in-law, Kentucky grants a $1,000 exemption and charges taxes ranging from 4% to 16%. Other heirs, including cousins, get a smaller $500 exemption and higher taxes of 6% to 16%.
Nebraska is harsher than most states in imposing taxes on just about everyone except a surviving spouse. Parents, grandparents, siblings, children, or other lineal descendants -- as well as the spouses of any of those individuals -- are subject to tax of 1% for property worth more than $40,000. Aunts, uncles, nephews, nieces, and their descendants have to pay a 13% tax rate on property worth more than $15,000, while other beneficiaries pay an 18% tax rate after a $10,000 exemption. One of the state's most famous residents, Omaha-born billionaire Warren Buffett of Berkshire Hathaway (NYSE:BRK-A) (NYSE:BRK-B), is unlikely to leave his heirs paying much in the way of inheritance tax, as he has already pledged the bulk of his billions in Berkshire stock to charity. Most charitable transfers are exempt from the tax.
Pennsylvania has the most restrictive set of exempt individuals of the states mentioned here, limiting exempt transfers to surviving spouses or to a parent if the deceased is a child who's 21 years old or younger. Transfers to children, grandchildren, and other direct descendants get taxed at 4.5%, while transfers to siblings incur a 12% tax. A 15% tax applies to other individual heirs and other recipients.
A last chance at the tax apple
Many policymakers believe that taxing transfers at death is an unconscionable insult to a grieving family, while others note that such taxes help to prevent massive accumulations of wealth among small groups of people. Regardless of your opinions on such taxes, you should be aware of the laws your state imposes on estates and inheritances in deciding where you want to live, especially during your retirement years.