Inheritance Tax: 5 Things You Need to Know

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The House of Representatives recently voted to repeal the estate tax. (It was a 240-179 vote, mostly along partisan lines, with Republicans in favor of the repeal.) There has been much controversy over this move, especially in light of growing wealth inequality, and some coverage of it has been calling it the inheritance tax. That makes matters rather confusing, though, because inheritance taxes exist, and they're different from the federal estate tax.

Just so we're clear, the federal estate tax is currently levied on estates that surpass $5.4 million in value -- $10.9 million for couples -- and only on the portion of the estate that surpasses those limits. So if you have a $6 million estate, only $600,000 faces the tax. If you think that's a steep limit, and one that you needn't worry about, you're right. It's estimated that the tax will only affect about 5,400 estates each year -- two-tenths of one percent of Americans. And wiping it out will eliminate about $22 billion in annual tax revenue -- an estimated $269 billion over the coming decade.

The inheritance tax, though, is different, and affects even fewer Americans largely because there is no federal inheritance tax. It exists only at the state level. Additionally, while the estate tax is levied against an estate -- thus its name -- an inheritance tax is assessed against an estate's beneficiaries.

Here are five more things to know about it:

Recently, only sixstates levied an inheritance tax. The states were Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. Interestingly, New Jersey features not only an inheritance tax but also a state-level estate tax. Inheritance taxes have become rather valuable for the states that impose them. Recently, for example, they generated close to $90million in annual revenue for Iowa, and close to $50million in Nebraska.
The amount of the inheritance tax will likely depend on the value of the assets bequeathed and the relationship of the recipient to the bequeather. Accordingto TurboTax, recent inheritance tax rates ranged from 1% to 20%. Spouses are generally exempt, and children sometimes are, too, or they mayface a lower tax rate. Typically, the less related you are to the deceased, the higher the tax rate you'll face. The folks at Nolo.com offer this example: "...in Maryland, parents, siblings and other close relatives can inherit $40,000 tax-free, and pay just 1% of the market value of inherited property over that amount. Tax rates for more distant inheritors start at 13% for amounts over $25,000."
And even within those states, not every heir will face the tax, as (much like the federal estate tax) it typically applies to inheritances above a certain threshold. Imagine that the inheritance tax in your state is 4% and the threshold is $1 million. If you receive $1.5 million, you'll only be taxed on the amount above $1 million, $500,000. Four percent of that is $20,000, which would be your inheritance tax.
Inheritance taxes are generally duewithin 9 to 18 months after the death of the bequeather. When assets are distributed from an estate, it's the jobof the estate's executor to file the inheritance tax return.
Besides the inheritance tax that some heirs will face, it's worth noting that if you inherit stocks or other assets to which capital gains taxes apply, any gains on them when you sell them will be taxable to you. Your cost basisin them won't be the cost basis of the generous person who left them to you, though. If your Aunt Edna bought shares of Scruffy's Chicken Shack for $50 apiece and then left them to you when they were valued at $100, your cost basis will be $100, not $50. If you sell them at $120, your gain will be $20, not $70.

The bottom line is that it's unlikely that you will face either the federal estate tax or a state inheritance tax. And if you do get hit with an inheritance, it's likely to be relatively modest, unless you've received assets from a total stranger. Still, be aware that each state's laws change all the time, and cash-strapped states may enact inheritance taxes or may boost existing inheritance tax rates in order to generate more funds.

And if you find that you're grumbling about estate or inheritance taxes being unfair, consider the argument of their proponents, such as William Gates, Sr., father of Bill Gates. He has spoken about how America invests heavily in research that fuels business growth and that, "It is clear that the folks who have become wealthy from this significant social investment did not do it alone. I believe their estates owe something back to the society that enabled the creation of that wealth."

Still, the taxation of estates and inheritances might be made simpler. As it is, inheritance taxes are often a second tax on an estate, after the estate tax. It might be more fair to simply tax the estate, and then let heirs inherit tax-free. That's not how things are now, though, so be aware of the existence of inheritance taxes.

The article Inheritance Tax: 5 Things You Need to Know originally appeared on Fool.com.

Longtime Fool specialistSelena Maranjian, whom you can follow on Twitter,has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.