Whether or not you have to pay inheritance tax depends on the state you live in, the size of the inheritance and your relation to the deceased. At the federal level, there is no tax on inheritances, but there is a federal estate tax on larger estates, which the estate, not the recipient, pays. If a relative leaves you money in a will, or you receive assets from a deceased relative through the probate process, you will have no federal inheritance tax liability - though you may have to pay income tax in respect of a decedent or income tax on inherited annuities. Some states do charge an inheritance tax, however, so the answer depends on your jurisdiction.
While state inheritance taxes, like estate taxes, are normally paid by the estate representative, or executor, before estate assets are distributed to the beneficiaries, the tax is technically on the recipient and not the estate. For this reason, the amount of tax that comes out of each beneficiary's inheritance can vary. For example, most states charge a different level of tax based on the beneficiary's relationship to the deceased. Some states also vary the percentage based on the amount of the inheritance.
States and Rates
As of 2012, nine states imposed an inheritance tax. The maximum tax rate ranged from 9.5 percent in Tennessee to 18 percent in Maryland. Generally, states that tax inheritances exempt a certain amount per recipient from taxation. They may also allow discounts for early filing. All states currently exempt spouses from inheritance tax.
State and Federal Tax
State inheritance taxes are paid over and above any U.S. federal estate tax. However, should the estate be large enough to be required to pay federal estate tax, state inheritance taxes can be deducted on the federal filing. The federal government will allow you to deduct the amount even if you have not actually paid it by the date you file federal estate taxes, so long as the amount, generally, is paid within four years.
Some states that impose an inheritance tax also impose a gift tax on any assets that are transferred within a few years before the giver's death. This is to discourage efforts to circumvent inheritance tax laws by giving assets away prior to death.
Leslie McClintock has been writing professionally since 2001. She has been published in "Wealth and Retirement Planner," "Senior Market Advisor," "The Annuity Selling Guide," and many other outlets. A licensed life and health insurance agent, McClintock holds a B.A. from the University of Southern California.