The old saying goes that nothing is certain except death and taxes. What about death taxes? These taxes can be avoided. Taxes are part of daily life in America—from sales tax to gasoline tax to the FICA tax. There’s also income taxes, property taxes, sin taxes… the list goes on and on. The average American spends 29.2 % of their income each year in taxes, according to Debt.org.
Your heirs could end up being taxed once again, even though you already give the government 29 cents for every dollar earned during your lifetime.
Depending on what state you live in, your heirs or your estate can get hit with a death tax bill—either an inheritance or an estate tax. Or vice versa, you can get hit with a death tax bill if you receive assets from a family member or friend’s will.
What is Inheritance Tax and Estate Tax?
Wealth transfer after death can be affected by estate taxes and inheritance taxes. They are basically the same thing. The only difference is who pays them.
According to InvestopediaAnyone who inherits assets from the estates of deceased persons is subject to an inheritance tax. An estate tax is imposed on the actual estate, before assets are distributed.
These taxes have a reputation of being the last twist of the taxman’s knife, since they are imposed on your assets or heirs after you die.
Inheritance and estate taxes—aka “death taxes”—have been legislated in a number of states across the country. The federal level has an estate tax. But that won’t be an issue for 99.9 percent of us.
The federal estate tax exempts assets up to $11.7 million for an individual and $23.4 millions for married couples. It doesn’t kick in until after those levels, and the federal estate tax can have a rate as high as 40 percent. The idea behind the federal estate tax was to prevent tax-free wealth in perpetuity among America’s wealthiest families.
Instead of dealing with the IRS, the inheritance and estate taxes that non-multimillionaires encounter are at the state level. Every state has its own rules. Each beneficiary may have to pay a different tax bill depending on how large the inheritance is.
This is because inheritance tax rates also depend on the beneficiary’s relationship to the deceased, not just the state they are in. Certain types of relationships are exempted from inheritance taxes in every state.
These States Don’t Collect Death Taxes
There are 32 states where there is no death-related tax. These states do not impose any inheritance or estate taxes on wealth transfers if you live with your beneficiaries. These include:
Alabama, Alaska, Arizona, Arkansas, California, Colorado, Delaware, Florida, Georgia, Hawaii, Idaho, Indiana, Kansas, Louisiana, Michigan, Mississippi, Missouri, Montana, Nevada, New Hampshire, New Mexico, North Carolina, North Dakota, Ohio, Oklahoma, South Carolina, South Dakota, Tennessee, Texas, Utah, Virginia, West Virginia, Wisconsin, Wyoming.
If you are a resident of one of these states, and inherit a property, business or bank account in a death-taxed area, you might be subject to an inheritance or estate tax.
The State Details
16 states and Washington, D.C. currently have inheritance or estate taxes. Only five have inheritance taxes—New Jersey, Nebraska, Iowa, Kentucky, and Pennsylvania. This number will decrease to four by 2025, as Iowa has eliminated its inheritance tax.
Washington, Oregon (or Minnesota), Illinois, New York; Maine, Vermont, Rhode Island; Massachusetts, Connecticut, Hawaii and the District of Columbia are just 12 states with an estate tax. Maryland is the only one that has an estate tax. Both an estate tax as well as an inheritance tax are possible.
Massachusetts and Oregon have the lowest estate tax thresholds. They tax all estates over $1 million.
Washington has the highest estate tax rate at 20 percent. However, it’s only applied to the portion of an estate’s value greater than $11,193,000.
Organization Is Key
When you know that you will be receiving an inheritance—or if you are planning for your retirement and don’t want your kids getting hit with a massive tax bill—organization is key. Wealth transfers can be an enormous blessing. But if they aren’t planned for properly, they can end up leaving a huge tax burden.
Holding an intergenerational family meeting with an estate planner and legal advisor—when everyone is healthy and in good spirits—is a smart move. They can discuss with everyone the implications for wealth transfer in each of the states where assets are held. You and your family will then be able to plan accordingly.
Trying to discuss financial matters while in mourning isn’t wise. This type of topic requires planning and research.
Plan for Death Taxes
It is a smart idea to include a strategy for death taxes in your plan for retirement and wealth building. You can avoid probate court and reduce disputes by setting up a trust, donating assets to charity, or gifting assets.
Planning for retirement and wealth transfer is not a one-size fits all approach. However, putting together a plan for your assets to end up with the most important people and causes in your life—instead of with the taxman—is a smart financial move. This is especially important if you or your beneficiaries are in a death tax state.