As the old idiom goes, nothing is certain but death and taxes. But what about death taxes? Can those 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. When you add it all up, Americans spend an average of 29.2 percent of their income in taxes each year, according to Debt.org.
Even though you are already giving the government more than 29 cents of every dollar you earn during your lifetime, your heirs might end up getting taxed again when you die.
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 Are Inheritance And Estate Taxes?
Inheritance and estate taxes are related to wealth transfer after death. They are essentially the same thing, the only difference is who pays the bill.
According to Investopedia, an inheritance tax is imposed on someone who receives assets from the estate of a deceased person. However, an estate tax is levied 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. At the federal level, there is only an estate tax. But that won’t be an issue for 99.9 percent of us.
The federal estate tax exempts the first $11.7 million in assets for an individual and $23.4 million for a married couple. 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. Each state has different rules. And, depending on the size of the inheritance, each beneficiary could possibly have a different tax bill to take care of.
This is because inheritance tax rates also depend on the beneficiary’s relationship to the deceased, not just the state they are in. In each state, there are certain types of relationships that are exempt for an inheritance tax.
These States Don’t Collect Death Taxes
There are 32 states that do not collect any sort of death-related taxes. If you and your beneficiaries live in any one of these states, there are no inheritance or estate taxes imposed on wealth transfer. They 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, and Wyoming.
However, if you live in one of these states and you inherit a home, business, or bank account that is located in a death-taxed state, an inheritance or estate tax might still apply.
The State Details
Currently, 16 states and Washington, D.C. have either estate or inheritance taxes. Only five have inheritance taxes—New Jersey, Nebraska, Iowa, Kentucky, and Pennsylvania. But that number will fall to four by 2025 because Iowa is eliminating its inheritance tax.
Twelve states have an estate tax: Washington, Oregon, Minnesota, Illinois, New York, Maine, Vermont, Rhode Island, Massachusetts, Connecticut, Hawaii, and the District of Columbia. Maryland is the only state that has both an estate tax and an inheritance tax.
The two states that have the lowest threshold for estate taxes are Massachusetts and Oregon. They impose taxes on all estates worth $1 million or more.
The highest estate tax rate in the country is in Washington 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 a huge 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 explain to everyone what the implications are for the wealth transfer in each state where an asset is held. Then, you and your family can plan accordingly.
Trying to discuss financial matters while in mourning isn’t wise. And this kind of topic requires research, planning, and consultation with professionals.
Planning For Death Taxes
Including a strategy for death taxes as you build your wealth and plan for retirement is a good idea. Options like establishing a trust, donating to charity, and gifting assets can help you and/or your family avoid probate court and minimize disputes.
There is no one-size-fits-all approach when it comes to planning for your retirement and a wealth transfer. 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. Especially if you and your beneficiaries live in a death tax state.