Do I have to pay taxes if someone leaves me money?

Inheritance taxes are paid when you receive money or property from someone’s estate after their death.  Once the executor of the estate has divided up the assets and distributed them to the beneficiaries, the inheritance tax comes into play. The tax amount is calculated separately for each individual beneficiary, and the beneficiary must pay the tax. For example, a state may charge a 5 percent tax on all inheritances larger than $2 million. Therefore, if your friend leaves you $5 million in his will, you only pay tax on $3 million, which is $150,000. The state would require you to report this information on an inheritance tax form.

This is different from estate taxes, which are federally imposed taxes on property transferred at your death.  The estate tax is imposed on the person leaving the property, not the beneficiary.  Therefore, the major difference between these two types of taxes is who is responsible for paying the tax.

Inheritance tax exemptions

Depending on your relationship to the decedent, you may receive an exemption or reduction in the amount of inheritance tax you must pay. For example, most states exempt a spouse from the tax when they inherit the property from another spouse.

Children and other dependents may qualify for the same exemption, though in some cases, only a portion of the inherited property may qualify. Generally, the higher rates of tax will be paid by those who inherit property from a decedent with whom they have no familial relationship.

States with an inheritance tax

The federal government does not have an inheritance tax. Inheritance taxes are only imposed on the state level and, as of 2013, there are only 8 states that impose this tax.  The eight states that impose an inheritance tax include Indiana, Iowa, Kentucky, Maryland, Nebraska, New Jersey, Pennsylvania and Tennessee.  Since state laws are always subject to change, you should check with your state’s tax agency if you are receiving an inheritance. Arkansas does not impose an inheritance tax.

In those states that do impose an inheritance tax, spouses may inherit without the estate incurring an inheritance tax. Other inheritors, such as children and domestic partners, may be entitled to a different exemption status and tax rate depending on which state they live in.

Do I have to pay taxes on a gift I receive while the giver is still alive? 

Another common question is whether the recipient of a gift has to pay taxes on that gift.  Generally speaking, the person making the gift is the person responsible for paying any required gift tax.  The giver is also responsible for reporting the gift to the IRS and to their state, if required.

On the other hand, the person receiving the gift does not have any immediate tax consequences.  This is because that gift is not included as part of the recipient’s taxable income.  There may be future tax consequences, however.  If the gifted property is later sold, then there may be a capital gains tax.