Depending on where the decedent lived, a surprise inheritance may come with another surprise: taxes that must be paid. Don't let a windfall become an expense.
Whether an inheritance comes out of the blue or is expected, in most cases there is an inheritance tax and, often, an estate tax that must be calculated and paid, according to NJ 101.5 in "What taxes apply when someone passes away?"
The amount of tax depends on the transfer amount, or "taxable estate," and who is receiving the transferred amount. The transfer amount is in essence the fair market value of the deceased's assets plus any life insurance proceeds. There are both federal and state estate tax laws to look at when evaluating a deceased's estate. The state where Grandma resided at the time of her death is important, rather than where the heirs live. If Grandma was a New Jersey resident at the time of her death, estate taxes could apply when assets are left to anyone other than her spouse.
The federal estate exemption amount is currently $5.45 million per person. You are only taxed if more than the exemption amount is transferred at death. However, if any lifetime taxable gifts were made by the deceased, it's possible the estate could be subject to estate tax even if the estate is less than the exemption amount. That's because a taxable gift is a gift in excess of the annual gift tax exclusion amount of $14,000 per person.
But if Grandma's taxable estate is less than the exemption amount—after adjusting for any lifetime taxable gifts—there would be no federal estate taxes due. New Jersey has a state estate tax exemption of only $675,000. As a result, many state residents will be subject to state estate taxes. But again, if Grandma's taxable estate is less than $675,000, there's no New Jersey estate tax due.
There's also the issue of state inheritance tax. The taxable estate for New Jersey inheritance tax purposes has two important adjustments: gifts made within three years of death are generally added back, and life insurance proceeds are exempt if paid to a named beneficiary (but not if they were paid to the estate of the deceased).
The good news is that you only have to pay the greater of the New Jersey estate tax or the inheritance tax, but not both. Also, immediate family members—including the spouse, grandparent, child, or grandchild—are exempt from the inheritance tax.
It is important to speak with an estate planning attorney who practices in the state where the deceased person lived about matters concerning estate and inheritance taxes. The laws vary from state to state, and they change over time, so the attorney needs to be a current and active practitioner in that state.
Reference: NJ 101.5 (March 1, 2016) "What taxes apply when someone passes away?"