Taxes are complex and the terminology surrounding them can be confusing. This is no less true with respect to estate planning. And while “estate tax” and “inheritance tax” are often used as synonyms, they actually have very distinct meanings. Knowing how inheritance taxes differ from estate taxes will help you prepare for any tax consequences that may attach to your estate or an inheritance you receive from one.
Inheritance taxes versus estate taxes: what’s the difference?
The primary distinction between an estate tax and an inheritance tax is who pays it. The estate tax is paid by the estate of a deceased individual, if the value of the estate’s taxable assets reaches a certain amount. Meanwhile, the inheritance tax is paid by someone who inherits property from an estate on the property that they inherit.
It’s important to understand that the inheritance tax is based on the state in which the deceased person (from whose estate the inheritance is taken) resided. That means if you receive an inheritance from someone who lived in a state with an inheritance tax, you may have to pay it.
Massachusetts has an estate tax. Estates that total at least $1 million in taxable assets are subject to it. However, Massachusetts does not have an inheritance tax. But even if you live in the state, the inheritance taxes of another state could affect you.
How the estate tax could affect you
There is both a federal and state estate tax. To be subject to either one, the value of taxable assets in the estate must reach a certain threshold. Generally, this threshold – also known as an estate tax exemption – is higher at the federal than the state level. As of 2022, estates that are valued at $12.06 million or more will be subject to the federal estate tax, which can be as high as 40%. Meanwhile, the Massachusetts exemption is $1 million, so estates with taxable assets totaling $1 million or more are generally taxed at a graduated rate that could be as high as 16%. There are exemptions for assets left to spouses or to charities, and there can be deductions based on funeral costs, debts of the decedent and costs associated with administering the estate.
How the inheritance tax could affect you in Massachusetts
Even though the state of Massachusetts does not have an inheritance tax, residents could still feel a pinch from it. As mentioned above, the question is whether the state in which the deceased individual resided has an inheritance tax. Currently, the following states impose one:
- Iowa
- Kentucky
- Maryland
- Nebraska
- New Jersey
- Pennsylvania
Whether a tax will be levied on the inheritance depends on a number of factors codified in the laws of each state, such as the value of the inheritance and who is inheriting (some family members are exempt). If you received an inheritance from someone who lived in one of the above states, you should talk with an attorney licensed in that state about potential tax consequences. There is no federal inheritance tax.
Could your estate plan be impacted by the inheritance tax?
Massachusetts residents should not worry about heirs in other states paying a tax on what they inherit, since our state has no inheritance tax. However, the tax is worth considering if you plan to relocate from Massachusetts to one of the states that levies it. In that case, you will want to discuss your estate planning goals with an attorney who is familiar with the inheritance tax rules.
As mentioned above, your estate could still be subject to taxes if it reaches a certain value. Fortunately, there are strategies you can adopt to lessen the taxes your estate pays and therefore pass more of your property on to your heirs.
If you have questions or concerns about either estate or inheritance taxes? Call to connect with our Estates & Trusts team today.