If an Arizona resident leaves you money, the good news is that there is no inheritance tax in Arizona and no Arizona estate tax. However, if Aunt Gladys in New Jersey left you her house, you'd have to pay New Jersey inheritance tax.
Arizona has no inheritance or estate tax. In some cases, heirs may have to pay tax on assets left to them from out of state.
Inheritance Tax Versus Estate Tax
Don’t confuse an inheritance tax with an estate tax. The latter is calculated by adding up all of the assets held in the deceased’s names. Such assets may include bank accounts, stocks, bonds, mutual funds, ETFs, business ownership, real estate, motor vehicles, antiques, jewelry and collectibles. The assets are valued as of the day of the owner’s death. If the estate’s value is above the federal exemption level, or if the person’s primary residence was in a state with an estate tax, the tax is paid within nine months of the decedent's demise by the estate administrator. Only after the estate tax is paid is the remainder distributed to beneficiaries.
The person receiving the inheritance pays an inheritance tax. Since there is no federal inheritance tax, inheritance taxes are only imposed by those states with such a tax. Rates vary according to blood ties. For example, depending on state law, a sibling inheriting money may not pay as much tax as a friend unrelated to the deceased would.
States With Inheritance Tax
Currently, only a few states impose inheritance taxes, and many of them do not impose taxes on lineal descendants of the deceased, such as children and grandchildren. Whether or not you must pay inheritance tax depends on your relationship to the deceased. If the deceased was your parent living in a state with an inheritance tax, you might not have to pay tax to the state, but if your uncle or a friend leaves you an inheritance, that’s a different story. Spouses are exempt from any such tax.
States that impose inheritance taxes include Iowa, Kentucky, Nebraska, New Jersey and Pennsylvania, while Maryland imposes an inheritance and an estate tax. The top rate in Nebraska is 18 percent; Kentucky and New Jersey are 16 percent; Iowa and Pennsylvania are 15 percent and Maryland is 10 percent. Nebraska and Pennsylvania also impose inheritance taxes, albeit relatively low percentages, on the children or grandchildren of the deceased.
Federal Estate Tax
Only the estates of the wealthy are subject to federal estate taxes. While the estate tax is not an inheritance tax, as it is paid to the federal government by the estate and not the heirs, such a tax can reduce the amount of money heirs receive. The Tax Cuts and Job Act signed into law by President Donald J. Trump on December 22, 2017, raised the federal estate tax exemption to $11,180 million per person, which means the exemption for a couple is over $22 million. That amount is in effect until 2025, and there is always the possibility that Congress will extend it. If the TCJA exemption is not extended, the amount exempt from federal taxes reverts to 2017 levels, which are still substantial. That’s roughly $6 million per person or $12 million per couple.
Under the new tax law, fewer than 1,000 estates annually are subject to federal estate tax, according to the New York Times. If you’re the heir of someone whose estate is subject to federal estate tax, the estate tax rate is 40 percent on the amount above the exemption.
States With Estate Taxes
If you are left an inheritance by someone in another state that doesn’t impose inheritance taxes and the estate value is under the federal exemption, you may still not receive as much of an inheritance as you think. If you’re an only child and sole heir of parents living in a state with an estate tax, that’s potentially a lot of money not going to you.
Washington, D.C. and 12 states have an estate tax, although in some states the exemption matches the federal level. New York, for example, has a $5.25 million exemption for 2018 but will match the federal exemption for those dying in 2019 and later. Washington, D.C., Hawaii and Maine have estate taxes that currently match the federal exemption. In Connecticut, the estate tax is levied on estates worth over $2.6 million; Illinois over $4 million; Oregon over $1 million; Maryland over $4 million; Massachusetts over $1 million; Minnesota over $2.4 million; Rhode Island over $1.537 million; Vermont over $2.75 million and Washington over $2.193 million.
Some states with estate taxes offer portability for married couples, meaning spouses can combine exemption amounts, while others do not permit this combination.
Inheritance Money and Income Tax
While you won’t have to pay inheritance tax per se in Arizona, you are taxed on the income you receive from your inheritance once it passes into your name. For example, if you inherit a bank account worth $1 million, you will owe taxes on the interest accrued after the date the account passed to you, but not the $1 million inheritance.
Avoiding State Inheritance and Estate Taxes
If you live in Arizona but expect an inheritance from someone living in a state that imposes inheritance and estate taxes, you may want to discuss ways to avoid these taxes with the individuals. In most cases, these are your parents, who might prove amenable to moving to a state that doesn’t impose such taxes, such as Arizona. If relocating isn’t an option, discuss estate planning alternatives with your family so they may preserve their wealth and avoid paying some or all of the state estate or inheritance taxes that may come due.
An estate planning attorney might recommend establishing an irrevocable life insurance trust for this purpose. When a trust is irrevocable, that means you cannot change the terms once it is established. From the IRS’s viewpoint, that, in essence, means the grantor or the person creating the trust is now separate from the estate. After opening the irrevocable trust, the individual then applies for life insurance and names the trust as the owner of the policy. Even though the grantor cannot manage the trust, she can appoint a trustee to manage it. While it’s common to name a family member, it’s often advisable to appoint a financial professional or lawyer to the position.
Inheriting From an Arizona Resident
What happens if you live in a state that imposes an inheritance tax and you are left an inheritance by an Arizona resident? It’s not an issue. The inheritance tax applies only to the state in which the deceased lived, not the state where their beneficiaries reside. Of course, you could experience a mix depending on where the assets of the resident were located. For example, say your aunt moved to Arizona from New Jersey, where you still reside. She owned a second home in New Jersey at the time of her death, which she left to you along with other assets. You won’t have to pay inheritance tax on the latter, but you will have to pay inheritance tax on the value of the New Jersey property.
- The Tax Foundation: Does Your State Have an Estate or Inheritance Tax?
- Arizona Estate and Trust Law: 2018 Changes to Estate and Gift Tax Laws
- IRS: What's New - Estate and Gift Tax
- New York Times: Heirs Inherit Uncertainty With New Estate Tax
- JRC Insurance Group: The Complete List of States with Estate Taxes (Updated for 2018)
- Can Married Couples Residing in Texas File Separate Tax Returns?
- How Do We File Taxes for a Living Trust That Has Been Maintained After Our Mother's Death?
- Do You Need to File Taxes on Inherited Property?
- Do You File the Deceased Person's Back Taxes Before You File the State Inheritance Tax?
- What Is the Difference Between Irrevocable & Revocable Trust?
- Tax Implications From a Distribution For an Irrevocable Trust to a Beneficiary
- The Responsibility for Paying an Inheritance Tax
- Are Distributions From Trusts Taxable?