An inheritance tax is a tax on a beneficiary’s receipt of assets from a deceased person. This article explores how inheritance taxes work generally.

Inheritance Tax Overview

An inheritance tax is a tax on a beneficiary’s receipt of assets from a deceased person. The beneficiary pays the tax as a percentage of the assets inherited. Rates generally vary based on the relationship between the estate owner and the beneficiary.

How Does It Work?

When a person dies, their assets are distributed according to the terms of their will or revocable trust, or if they did not have a will or revocable trust, according to the state’s laws. Depending on the value of the assets and the beneficiary’s relationship to the deceased, these gifts may be subject to inheritance tax.

There is no federal inheritance tax, but some states have their own inheritance taxes. However, even in states with an inheritance tax, spouses and, in most cases, children are exempt. Often, specific types of assets are exempt from inheritance tax as well.

Which States Impose an Inheritance Tax?

The five states that impose an inheritance tax are:

1. Pennsylvania
2. Maryland
3. Nebraska
4. Kentucky
5. New Jersey

What is the Inheritance Tax in New Jersey?

The New Jersey inheritance tax applies to individuals who receive assets from a deceased New Jersey resident and who are not exempt from the tax. The law divides beneficiaries into four classes: Class A, Class C, Class D, and Class E (there is no Class B).

There are two classes that are completely exempt. Class A includes partners, ancestors, and decedents of the deceased person. The decedent’s spouse, civil union partner, children, grandchildren, great-grandchildren, step-children, parents, and grandparents are all Class A beneficiaries. Class E includes non-profits. Bequests to these beneficiaries will not incur any inheritance tax.

But the other two beneficiary classes do face inheritance tax. Class C includes the deceased person’s siblings and half-siblings, and the spouses of the deceased person’s children. Bequests to Class C beneficiaries are taxed as follows:

• 11% tax on any amount over $25,000 up to $1,100,000 (no tax below $25,000).
• 13% on any amount over $1,100,000 up to $1,400,000.
• 14% on any amount over $1,400,000 up to $1,700,000.
• 16% on any amount over $1,700,000.

Class D includes everyone else: nephews, nieces, cousins, fiancés, and friends. Bequests to Class D beneficiaries are taxed as follows:

• 15% on any amount up to $700,000 (unless the bequest is less than $500).
• 16% on any amount in excess of $700,000.

New Jersey Inheritance Tax Example

An example will help illustrate how New Jersey’s inheritance tax works. Let’s say Bob was a New Jersey resident who passed away, leaving his $4 million estate to his childhood best friend Jon. Because Jon is a Class D beneficiary, he would be responsible for paying New Jersey inheritance tax on his full inheritance. He would owe around $633,000 in inheritance tax. On the other hand, if Jon was Bob’s son, he wouldn’t owe any inheritance tax.

What’s the Difference between an Inheritance Tax and an Estate Tax?

An inheritance tax and an estate tax are similar in the sense that both are taxes on the transfer of assets to a deceased person’s heirs. But they work differently. An estate tax is imposed on the estate of the deceased person, and it is calculated on the total value of the assets when they are passed on. In contrast, an inheritance tax is imposed on the beneficiaries themselves, based on their receipt of the assets. There is a federal estate tax, but no federal inheritance tax. Only five states impose an inheritance tax, but 12 states and the District of Columbia impose an estate tax.

Conclusion

The inheritance tax can be a significant burden for beneficiaries. It is essential to understand if it applies to you, how it works, and the different strategies that can be used to reduce or avoid it. By understanding the differences between inheritance tax and estate tax, as well as the specific rules, individuals can plan to minimize the amount of taxes their beneficiaries will have to pay.

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