When you are receiving an inheritance, you may wonder if you are required to pay a tax on the inheritance. The answer is probably not.
The recipient of an inheritance is not going to be paying transfer taxes on the inheritance unless there is an inheritance tax in the state within which the recipient resides. Only six states have an inheritance tax (though Kentucky is one of them). There is no federal inheritance tax.
An inheritance tax is not the same thing as an estate tax. An inheritance tax is levied on each individual inheritance that inheritors receive if they are not exempt. An estate tax is levied on the entirety of an estate before the assets are distributed to the heirs.
If you were in line to receive an inheritance from an estate that was subject to the estate tax, you would not be paying a tax directly. However, if you were receiving a percentage of the entire estate, the tax that is imposed on the estate would decrease the amount that you inherit.
Are Gifts Taxable?
While we are on the subject, you may wonder if you have to pay income tax on large gifts that are given to you by someone who is still alive. Once again, the answer is no.
However, the person giving the gift may be required to pay a tax because we have a federal gift tax in place.
The gift tax is unified with the federal estate tax. The amount of the unified exclusion in 2019 is $11.4 million. Gifts that are given that exceed this amount would be subject to the gift tax. The maximum rate of the gift tax and the estate tax is 40 percent.
To provide clarity, because this is a unified exclusion, it applies to the combination gifts that have been given by an individual coupled with the value of his or her estate. To provide a very simple example, let’s say that your father gave you a cash gift of $11.4 million (wouldn’t that be nice?). He could give you this gift tax-free using the unified lifetime exclusion.
However, there would be nothing left to apply to future transfers. If he wanted to give a large gift to someone else, or another large gift to you, it could not be given tax-free. In addition to this, there would be no exclusion left to apply to his estate. As a result, the entirety of his estate would be potentially subject to the federal estate tax.
Tax Efficiency Strategies
There are steps that can be taken to mitigate estate tax exposure. Those who are in possession of assets that exceed the exclusion amount should certainly discuss their options with a licensed estate planning attorney.