This comprehensive guide explains inheritance taxes, their differences from estate taxes, and how they apply based on state and federal laws. It covers exemptions, tax calculations, and strategies to minimize liability through will planning and spousal deductions. Understanding these rules helps beneficiaries and estate planners manage potential tax obligations effectively. Knowing the specifics of state and federal exemptions ensures better estate planning, reducing tax burdens and ensuring smoother asset transfers across jurisdictions.
Inheritance tax is a levy on the assets or property received through inheritance. Unlike federal estate taxes, which apply to the estate itself, the recipient is responsible for paying inheritance taxes. Only six states currently impose this tax, and exemptions may apply. These taxes are sometimes called death taxes. Some states charge both state and federal inheritance taxes, while others do not. Whether you owe depends on your residence, where the decedent lived, or where the inherited property is located.
Inheritance tax differs from estate tax, which is based on the total value of the decedent’s estate. Inheritance tax applies to each beneficiary’s received property, and the beneficiaries are responsible for its payment. Occasionally, testators specify in their will that the estate executor settles inheritance taxes, relieving beneficiaries of this obligation.
Inheritance tax is triggered when assets are transferred to heirs, calculated separately for each recipient. For example, inheriting assets worth $5 million may incur a 5% tax on amounts exceeding certain thresholds, resulting in a tax bill of $150,000 on $3 million. Not all assets are taxed; some are exempt, and spouses usually pay no inheritance tax on each other’s assets. Proper will planning is vital to manage potential tax liabilities, especially for assets passed directly to children or grandchildren. States like Kentucky exempt certain heirs, such as children and parents, from inheritance taxes or apply lower rates.
Federal Estate Tax Exemption Under 2017 laws, the federal estate tax exemption stands at $5.49 million. Estates below this value are exempt from federal estate taxes. The federal tax rate is 40% on amounts exceeding this exemption. For example, on an estate worth $8 million, the taxable amount is $2.51 million, resulting in approximately $1.004 million in federal estate taxes.
Only a few states — including Maine, Maryland, Massachusetts, Minnesota, New Jersey, New York, Oregon, Rhode Island, Tennessee, and Washington — currently impose their own estate taxes. If the decedent resided outside these states or owned property elsewhere, heirs are generally not subject to state estate taxes. If multiple states' properties are involved, the estate must surpass each state's exemption threshold to owe taxes. State estate exemptions vary widely, from $675,000 to $5.49 million. Payments are deducted from the inheritance after taxes are settled. To reduce estate tax burden, spouses who are U.S. citizens can utilize unlimited marital deduction, leaving assets tax-free, whereas non-citizen spouses may not qualify for this benefit.
