Does your ability to pass on your wealth to your heirs depend on where you live ... and die? Indeed it does. Federal estate taxes apply no matter where you live within the U.S., but eighteen states subject their citizens to estate taxes or inheritance taxes. The difference between the two is that estate taxes are subtracted from an estate before it is dispersed to the heirs, while the inheritance tax applies to the heirs — even if they live in a different state than the deceased.
Inheritance taxes only apply in six states: Nebraska, Iowa, Kentucky, Pennsylvania, New Jersey and Maryland. Most of those states exempt spouses and children, and siblings are often exempted as well. Nebraska is the only state where there are no 100% exemptions — immediate relatives are subject to a 1% tax on inheritance amounts above $40,000. Nebraska also has the highest top inheritance tax rate at 18%, while the others range from 10% to 16%.
Each state has exemptions based on the amount of the inheritance and the heir's relationship to the deceased, which vary from state to state. If you receive an inheritance from someone who lived in one of the inheritance-tax states, check that state's laws for details. States categorize heirs into types for the purposes of assigning exemptions and tax rates, ranging from two categories in Maryland to seven in Iowa.
While any of the other 32 states are by definition the "best" states to die in due to lack of applicable state taxes, two of the above are arguably the worst because they impose both inheritance and estate taxes. Maryland imposes a 16% tax on estates above $1.5 million, and New Jersey has a scaled estate tax ranging from 0.8% to 16.0% on estates over $675,000.
Here are the remaining states with estate taxes, along with the income exemption limit and range of tax rates, as of 2015 (with one exception in the following paragraph):
- Connecticut: 7.2% to 12.0% tax on estates over $2 million.
- Delaware: 0.8% to 16.0% tax on estates over $5.43 million.
- Hawaii: 0.8% to 16.0% tax on estates over $5.43 million.
- Illinois: 0.8% to 16.0% tax on estates over $4 million.
- Maine: 8.0% to 12.0% tax on estates over $2 million.
- Massachusetts: 0.8% to 16.0% tax on estates over $1 million.
- Minnesota: 9.0% to 16.0% tax on estates over $1.4 million.
- Oregon: 0.8% to 16.0% tax on estates over $1 million.
- Rhode Island: 0.8% to 16.0% tax on estates over $1.5 million.
- Vermont: 0.8% to 16.0% tax on estates over $2.75 million.
- Washington: 10.0% to 20.0% tax on estates over $2.054 million.
- District of Columbia: 0.8% to 16.0% tax on estates over $1 million.
Tennessee was on this list through 2015, with an inheritance tax exemption limit that rose for four consecutive years (up to $5 million in 2015). Their estate tax ends for the 2016 tax year and beyond. Tennessee's legislature believes that this will attract wealthy retirees to the state and stop the flight of the ones they already have. Time will tell if they are right.
Since inheritances are often passed through to spouses and children, and the exemption sizes are generally large, most people are not going to run into any issues with estate or inheritance taxes. However, it is a good idea to understand the inheritance and estate tax situation in your state. State laws can be subject to frequent change, so as you start your estate planning process, give the tax rates in your state another look. Your heirs will thank you in advance.