Are these terms used to describe state and federal income taxes on inheritances? Are they used interchangeably?
Let’s look at the answers to these questions so you can go forward with a solid understanding of taxes on inheritances.
You do not have to report a direct inheritance that you receive through the terms of a will when you file your income tax returns. Insurance policy proceeds fall into the same category.
The reason why inheritances are tax-free is because the decedent paid taxes before they accumulated the assets that would be in their estate. A tax on the inheritance would be double taxation, and this would not be fair.
This being stated, this logic goes out the window when it comes to distributions that exceed a certain amount as you will learn in the next section.
Distributions from the principal in a living trust would not be taxable, but you would have to report distributions of the earnings.
If you are the beneficiary of a Roth individual retirement account, the distributions would not be taxable. Traditional account beneficiaries pay taxes on the distributions, because these accounts are funded with pre-tax earnings.
Federal Estate Tax
There is a federal estate tax that is in fact an instance of double taxation. Most people do not have to worry about it, because there is a high exclusion that allows you to transfer a certain amount before the tax would be applied on the remainder.
In 2021, the exclusion is $11.7 million, and the maximum rate is 40 percent.
This tax is not applicable on transfers between spouses because there is an unlimited marital deduction. A surviving spouse would have two exclusions to use, because they can use their own exclusion and their deceased spouse’s exclusion.
State-Level Inheritance Taxes
As we have stated above, an estate tax is levied on the entire taxable portion of an estate before it is transferred to the heirs, so there is just one instance of taxation.
An inheritance tax works in a different manner. It can be levied on distributions to each individual inheritor, so it could be imposed multiple times what a single estate is being administered.
There is no federal inheritance tax, but there are six states in the union that have state-level inheritance taxes. Fortunately, Ohio is not one among them. If you inherit property that is located in a state that has an inheritance tax, it would be a factor for you.
State-Level Estate Taxes
You may have heard people talk about an Ohio estate tax at some point in your life. There was a state-level estate tax in our state, but it was repealed, so there has been no estate tax here since 2012.
A dozen states have state-level estate taxes, and if you own property in one of these states, the tax would be levied if its value exceeds the exclusion in that state. It should be noted that the state-level exclusions are typically lower than the federal exclusion.
For example, the exclusion in Hawaii and Oregon is just $1 million. The highest state-level exclusion is the $5.93 million that is in place in New York.
Access Our Estate Planning Worksheet!
You are here because you are looking for estate planning information, and you can really build on your knowledge if you complete our worksheet. This resource is offered free of charge, so you should definitely take advantage of this opportunity.
Your copy can be obtained right now if you head over to our worksheet access page and follow the simple instructions.