When you inherit money or property, the odds are good that you won't have to pay inheritance tax on it. Only a handful states impose an inheritance tax, so unless you or the deceased live in one of those states, or you inherit property there, there's no tax. If you inherit a payable-on-death account, you can bypass probate but it doesn't help you dodge any inheritance taxes that are due.
Payable on Death Accounts are Taxable
Payable-on-death accounts are exactly what they sound like. The account owner names you as the beneficiary for her bank account or CD. As soon as you present the bank with proof of her death, you become the new owner of the POD account. There's no limit to how much money the deceased can leave to a POD beneficiary. If the money is considered community property, though, the deceased's spouse may be able to claim half of it.
If you become the owner of a POD account after someone's death, you may have to pay an inheritance tax depending upon the state in which you inherited the account. A POD bank account is taxable in the same way any other inheritance is taxable.
As of 2018, only Iowa, Kentucky, Maryland, Nebraska, New Jersey and Pennsylvania impose an inheritance tax. Indiana once had an inheritance tax statute, but it was repealed in 2013, and any inheritances from decedents who died after December 31, 2012, are not subject to the tax. If you inherited a POD in Indiana, the date of death will determine whether inheritance tax will apply.
Outside of those states, you're off the hook as far as inheritance taxes are concerned. What's more, even in these states, there's no tax if you inherit the POD account or other assets from your spouse. Some states also exempt the deceased's children from inheritance tax, or only require a minimum payment. The more distant your relationship, the more you pay: if a good friend names you on his POD account, you pay the full tax.
Be warned, however, that your inheritance may still be subject to the federal estate tax, which is different from an inheritance tax, and your state may also assess its own estate tax on top of that.
Federal Estate Tax for 2018
Inheriting a POD doesn't exempt the account from estate tax, either. Estate tax is assessed against the person who gives the gifts, and it is assessed upon death against the total gifts that person made in her life up until her death, to anyone. However, for the 2018 tax year (which means for people who pass away between January 1, 2018 and December 31, 2018), the estate tax does not apply to any individual until their total gifts over their life exceed $11.2 million. Further, even if the deceased had that much money, it's the estate that has to pay the bill, not you. However, the executor can legally tap your inheritance to pay the tax, or the deceased's other assets, if necessary. So if you happen to inherit $12 million after your distant aunt dies in 2018, the executor of the estate can reduce that amount to cover the estate tax on the $800,000 above the threshold.
Federal Estate Tax for 2017
The threshold for taxation of gifts was much lower in 2017. If your decedent died in 2017, the threshold was only $5.49 million, and any gifts above and beyond that amount made during his life will be subject to the estate tax. For example, if your distant aunt died in 2017 and not 2018 and left you $12 million in a POD, the estate tax would be assessed on $6.51 million, which is the difference between your inheritance and the threshold.