In the U.S., 32 states do not apply death taxes—either inheritance or estate taxes—but there are reasons you still might get hit with a bill.  

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In much of the recent talk about taxation policies, there's been a resounding silence about one major area of wealth transfer: inheritance taxes. That's because the federal government does not impose an inheritance tax; state governments do. Of course, each state has different rules, and depending on the size of the inheritance, each beneficiary may be hit with a different-sized bill.

Do you have to pay taxes on inheritance?

The long and short of inheritance taxes are that these levies are paid by the living beneficiary, who receives an inheritance. Confusingly enough, both federal and state governments can apply estate taxes, which are levied against the assets that are bequeathed. 

When organized properly, these wealth transfers may be a financial boon that helps pay for college, launch businesses, and keep valuable properties within a family. However, to ensure that beneficiaries are properly prepared for the debt and tax burdens that might come with an inheritance, it's best to hold a family meeting with an estate planner and legal advisor who can explain the implications for each state where an asset is held.

As unpleasant as this might sound, you should do it while everyone is in good health and high spirits; no one wants to disentangle tax liabilities while in mourning. These kinds of sensitive and costly financial issues are ones worth researching well before there's an immediate need to know.

United States of America map formed with american dollars bills
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Where do estate and inheritance taxes exist?

The very basics are that only five states apply an inheritance tax: New Jersey, Nebraska, Iowa, Kentucky, and Pennsylvania. Twelve have an estate tax: Washington, Oregon, Minnesota, Illinois, New York, Maine, Vermont, Rhode Island, Massachusetts, Connecticut, Hawaii, and the District of Columbia. The great state of Maryland collects both. 

That leaves 32 states that do not collect death-related taxes: Alabama, Alaska, Arizona, Arkansas, California, Colorado, Delaware, Florida, Georgia, Hawaii, Idaho, Indiana, Kansas, Louisiana, Michigan, Mississippi, Missouri, Montana, Nevada, New Hampshire, New Mexico, North Carolina, North Dakota, Ohio, Oklahoma, South Carolina, South Dakota, Tennessee, Texas, Utah, Virginia, West Virginia, Wisconsin, and Wyoming.

But if you live in these states, don't breathe a sigh of relief just yet. Remember: Even if the beneficiary doesn't live in these states, but an inherited business, home, or bank account does, those taxes still might apply. 

What's the best way to plan for these taxes?

To better estimate and project these possible outcomes, an intergenerational planning meeting could really do the trick. Some families appreciate the transparency that comes from establishing a trust, which can minimize disputes and avoid the need for probate court. In addition, trusts are taxed differently than individuals, and there is more certainty about who will bear the costs.

Other families may consider gifting assets while an elder or chronically ill person is still alive. While these gifts can be subject to taxation too, there are exceptions for tuition and medical expenses. And gifts to children may also be excluded. For people planning to pass down wealth to friends, political organizations, and distant relatives, other considerations may apply. Donations to a charity, for example, can be tax-deductible. 

Just as there's no one-size-fits-all approach to wealth-building, there is also no singular approach to transferring valuable or sentimental assets. Instead, plot a roadmap to and from the most important people and causes in your life. For some, this will look like a family tree, but for others, it could look like a much more complicated network. If the network crosses state lines or international borders, it will be even more important to prepare everyone for their role and responsibilities. 

If inheritance tax sounds intimidating, then start small with major wins, like updating the beneficiary forms on your bank accounts and employer-led retirement accounts. Ask family members and friends to do the same. Consider using the holiday season as a time to organize documents such as insurance information and house titles and deeds. Securely make them accessible to those who might need them if you're unavailable. Gift organizational planning books and secure digital filing apps that will help everyone stay on the same page.

And even if you're socially distancing for the holidays, remember that estate planners will do consultations over video chat. So there's no excuse to wait another year to clarify inheritance and estate plans.