When thinking about what happens to your assets after you pass away, most people focus only on federal estate taxes; however, many states also have their own estate or inheritance taxes. These state taxes can apply even if no federal estate tax is owed, which often surprises families. Here’s what you need to know.
Estate Tax vs. Inheritance Tax: What’s the Difference?
Although they sound similar, these taxes work very differently.
Estate Tax
- An estate tax is imposed on the total value of your assets when you pass away.
- The estate pays the tax before assets are distributed to your heirs.
Inheritance Tax
- An inheritance tax is charged to the beneficiaries who receive the inheritance.
- Each beneficiary may pay a different amount depending on the value of what they received and how they are related to you.
Several states have one of these taxes, as outlined below. Maryland is currently the only state that has both an estate tax and an inheritance tax.
States with an Estate Tax
- Connecticut
- District of Columbia
- Hawaii
- Illinois
- Maine
- Maryland
- Massachusetts
- Minnesota
- New York
- Oregon
- Rhode Island
- Vermont
- Washington
States with an Inheritance Tax
- Kentucky
- Maryland
- Nebraska
- New Jersey
- Pennsylvania
Important Things to Consider When Planning
Where You Live Matters
- Your state of residence usually determines whether state estate or inheritance taxes apply.
- You may also owe taxes in a state where you own property, even if you don’t reside there.
Lower State Limits
- Many states start taxing estates at much lower amounts than the federal government.
- An estate can avoid federal estate tax but still owe state tax.
Who Inherits the Assets
- In inheritance tax states, immediate family members (for example, spouses and children) may owe little or no tax.
- Friends or distant relatives often pay higher taxes.
Gifts Made During Your Lifetime
- Giving assets away while you’re alive can sometimes reduce estate or inheritance taxes; however, be mindful of potential federal and state gift tax ramifications.
- Some states include gifts made shortly before death in an estate, so timing is important.
Who Pays the Taxes
- Your estate planning documents should clearly indicate who bears responsibility for any state taxes, helping avoid disputes down the road.
Married Couples
- State rules don’t always follow federal rules, which can make planning more complicated for married couples.
Moving to Another State
- Residing in a state without estate or inheritance taxes can reduce or eliminate these taxes and you’ll want to make sure you follow that state’s residency rules.
- If you move to a different state, you’ll want to review your estate planning documents and how they interact with the tax laws of that state.
Laws Change Often
- State tax laws change frequently, so your estate plan should be reviewed regularly to ensure your goals are still being met.
Examples of State Estate and Inheritance Taxes
Massachusetts Estate Tax
Massachusetts has an estate tax and requires a state estate tax return if the decedent’s federal gross estate plus adjusted taxable gifts exceed $2,000,000. Currently, the federal threshold for filing an estate return is $15 million, so an estate can owe Massachusetts estate tax even when it owes no federal estate tax.
Kentucky Inheritance Tax
Kentucky’s inheritance tax is based on who receives the property and is not based on the total size of the estate. Beneficiaries are grouped into classes with different exemption rates.
- Class A beneficiaries include close family, such as spouses, children, grandchildren, parents, and siblings. These beneficiaries are fully exempt from inheritance tax for deaths after June 30, 1998.
- Class B beneficiaries include more distant relatives, such as nieces and nephews. These beneficiaries generally receive a $1,000 exemption amount and pay inheritance tax on amounts over the exemption amount.
- Class C beneficiaries include all persons not included in Classes A or B. Beneficiaries in Class C receive a $500 exemption amount and pay inheritance tax on amounts over the exemption amount.
Final Thoughts
State estate and inheritance taxes can be confusing and vary widely depending on where you live and own property. State filings may be needed even when federal filings are not.
We can help you understand your state estate and inheritance tax exposure and help you develop an estate plan that minimizes taxes while achieving your personal goals.
Have questions about how this topic may affect you? Our team is here to help you navigate the details and make informed decisions.