Calculating Your Inheritance Tax: Everything You Need to Know

Calculating Your Inheritance Tax Everything You Need to Know

Your financial status will definitely improve if you receive news that you are inheriting a sum of money or an asset from a deceased parent or relative but it is very important to know whether you will be paying inheritance tax on this money or asset or not. If you will be paying, it is also important to know how much the inheritance tax bill will be.

The amount you will pay as inheritance tax depends on which state the deceased was residing in and how close you are with the deceased in familial terms. Also, there are certain conditions which guarantee that you will not be paying an inheritance tax. For example, if you are the spouse of the deceased, any money left for you will be tax- free. When you have confirmed that you will be paying, the tax bill depends on inheritance tax rates and tax and exemption thresholds.

Accurate calculation of your inheritance tax is a very important legal requirement especially when an organization like the IRS is concerned. You do not want to be picked up by the IRS and fined up to $250,000 or even jailed for evading inheritance taxes simply because you did not know that you have to pay them. To prevent this, you must be up-to-date in terms of the information needed in calculating your inheritance tax and whether there are exemptions you can take advantage of.

While there are  specific things you must know, there are a number of general rules. First, inheritance taxes are progressive. As such, the higher the inheritance, the higher the tax. Second, people with no familial relationship with the deceased pay the highest inheritance tax rates. Lastly, beneficiaries can qualify for exemptions which are computed based on the whole or partial value of the inheritance. The following are information you must have before calculating your inheritance tax;

Are you the sole beneficiary of the property or asset on which you want to pay tax?

Before deciding to pay inheritance tax and actually calculating the tax, you need to verify that you are the sole beneficiary of a particular property before making valuations for tax purposes. This is necessary in order to prevent legal misrepresentations  down the line. Seeking professional legal advice is critical at this stage. You must also investigate the extent of liability on a property or asset before evaluating it for taxation. Issues related to ownership of assets between beneficiaries must be resolved through legal means before inheritance taxes are computed. This is necessary because these taxes are computed using the value of the inheritance of each individual.

Does your state mandate the payment of inheritance tax?

The second thing you need to know is whether the state of the deceased mandates the payment of inheritance taxes. The US does not have a federal inheritance tax law but six states do. These are New Jersey, Nebraska, Kentucky, Iowa, Maryland and Pennsylvania. If you are a beneficiary of an estate and the deceased lives in any of these states you will be required to pay an inheritance tax. If you live in any of these states while the deceased lives in a state that does not require inheritance taxes then you will not pay an inheritance tax. Summarily, the payment of inheritance tax is determined by where the deceased lived, not where the beneficiary lives.

What are the inheritance tax rates and exemption thresholds for the state of the deceased?

The inheritance tax rates and exemption thresholds are important information to have when calculating your inheritance tax. The states that mandate the payment of inheritance taxes have different rates and exemption thresholds. These rates form the basis of calculating the inheritance tax and you may  have to engage the services of a professional for accuracy.

For Iowa, the tax rate varies from 5% – 15% depending on the value of the inheritance and the familial relationship you have with the deceased. Iowa has an exemption threshold of $500 for charity purposes and spouses, children, grandchildren, stepchildren, parents and grandparents are exempted from paying inheritance taxes. This is different from Nebraska where the inheritance tax rate runs from 1% to 18% with an exemption threshold of $10,000-$40,000. In Nebraska also, only spouses and charities are exempt from paying inheritance taxes.

New Jersey has the broadest spectrum of individual categories granted exemptions. The exemption threshold stands at $25,000 while the inheritance tax rate is between 11%- 16%. You should engage a  professional in interpreting the inheritance tax laws for these states.

The value of the inheritance will determine if you will be paying an inheritance tax

The inheritance tax you will be paying is determined by the value of the assets you inherited. In the states where inheritance taxes are paid, payment is triggered only after the value of the inheritance crosses a particular threshold. These thresholds are subjected to annual changes but have been consistently pegged at $1 million. This explains why only 2% of American taxpayers will ever pay inheritance taxes in their lifetime.

The inheritance tax is calculated on an individual basis with a stated threshold as the baseline. For example, if you are paying inheritance tax to the state of Iowa and the going rate is a 3.5% tax on all inheritances above $1 million. The tax you will be paying on $3million left to you by an uncle will be 3.5% of $2 million or $70,000.

Be ready to engage the services of professional

Depending on the size of the inheritance and the state of residence of the deceased, you may need to actually employ an inheritance funding company. Inheritance tax laws are often changed annually and become more complex. This is especially true if inherited assets are located in different states. You will need a professional to understand these laws and guide you in calculating inheritance taxes. In the long run, this is much cheaper than trying to understand these laws and filing the tax returns yourself. 

The views expressed in this article are those of the authors and do not necessarily reflect the views or policies of The World Financial Review.