It’s difficult to go through life without accumulating some combination of savings, valuables, and personal mementos. After your death, your personal possessions, as well as any money you have in bank accounts, will be passed on to your survivors.

In some cases, survivors pay estate tax on the money they inherit. However, inheritance tax laws have changed over the years, and often heirs don’t owe money on the assets their loved ones pass on. Here’s what you need to know about inheritance tax as you work on your estate planning.

What is Estate Tax?

Estate tax, often referred to as the "death tax," is a federal tax imposed on the transfer of the decedent's estate before distribution to any beneficiaries. It's calculated based on the net value of the deceased individual's assets at the time of their death, including real estate, securities, cash, and other assets, after deducting debts and other allowable expenses. Estate tax is a concern for individuals with significant assets, as it directly affects the wealth passed on to their heirs.

Key Features of Estate Tax

Taxable Estate: The taxable estate includes the total value of all assets minus liabilities, certain deductions, and bequests to surviving spouses and charities, which are typically exempt from estate tax.

Exemptions: The Internal Revenue Service (IRS) sets an exemption limit, which is the amount up to which an estate is not subject to tax. For 2024, the federal estate tax exemption is significantly high, allowing many estates to pass to heirs tax-free. However, this exemption amount is subject to change based on legislative action.

Tax Rates: For estates that exceed the exemption limit, the tax rate is progressive, meaning the rate increases as the value of the estate increases, up to a maximum rate.

State Estate Taxes

In addition to federal estate taxes, some states impose their own estate taxes, which can have lower exemption thresholds. The existence and rates of state estate taxes vary by state, making it important for estate planning to consider both federal and state tax implications.

Do I Have to Pay Taxes on an Estate?

Navigating the complexities of tax obligations after receiving an inheritance is a crucial aspect of managing an estate. Whether you're an executor of an estate or a beneficiary, understanding your tax responsibilities can help ensure compliance with tax laws while minimizing potential liabilities.

Estate Tax vs. Inheritance Tax

First, it's important to differentiate between estate tax and inheritance tax:

Estate Tax: Levied on the total value of the deceased person's estate before the assets are distributed to the beneficiaries. The federal government and some states impose estate taxes, but only estates exceeding certain thresholds are subject to these taxes.

Inheritance Tax: Charged to the individuals receiving an inheritance from an estate. Not all states have an inheritance tax, and rates can vary depending on the relationship to the deceased and the value of the inheritance.

Federal Estate Tax

The federal estate tax applies only to estates exceeding a significant exemption threshold, which is $13.61 million for individuals passing away in 2024. This means that estates valued below this amount are not subject to federal estate taxes. The rate for estates above this threshold can be substantial, making it essential for estates of this size to engage in strategic planning to minimize tax liabilities.

State-Level Taxes

State Estate Taxes: Some states impose their own estate taxes, and these can have lower exemption thresholds than the federal estate tax. Whether and how much you owe will depend on the state laws where the deceased person was a resident.

State Inheritance Taxes: A few states charge inheritance taxes, which vary depending on the beneficiary's relationship to the deceased. Spouses are often exempt, while distant relatives and non-relatives may face higher rates.

Income Taxes on Inherited Assets

Beneficiaries might not owe estate or inheritance taxes but could be subject to income taxes:

Income in Respect of a Decedent (IRD): Certain types of inherited assets, such as retirement accounts or annuities, may be subject to income tax when distributions are taken.

Capital Gains Tax: If you sell inherited property or investments, you may be subject to capital gains tax based on the difference between the sale price and the asset's value at the time of the original owner's death (the "stepped-up" basis).

Exemptions and Deductions

There are various exemptions and deductions that can reduce or eliminate estate tax liabilities, including transfers to a surviving spouse and charitable donations. Proper estate planning can leverage these provisions to minimize taxes.

What Assets Are Subject to Estate Taxes?

Understanding which assets are included in this valuation is crucial for both estate planning and for executors managing the estate's tax obligations. Here's an overview of the types of assets that typically contribute to the estate tax calculation:

Real Estate

All real estate owned by the deceased, including primary residences, vacation homes, rental properties, and land, is included in the estate's valuation. The market value at the time of death is generally used for these assets.

Cash and Bank Accounts

All liquid assets, such as cash on hand, savings accounts, checking accounts, and certificates of deposit, are part of the estate's taxable value.

Investments

Investment portfolios, including stocks, bonds, mutual funds, and other securities, are valued based on their market price at the time of the decedent's death and contribute to the estate's taxable amount.

Retirement Accounts

Retirement accounts, such as 401(k)s, IRAs, and pension plans, are included in the estate's value. The tax treatment of these accounts can be complex, as they may also be subject to income tax when distributions are made to beneficiaries.

Life Insurance Policies

Life insurance proceeds are included in the estate's taxable value if the deceased was the owner of the policy, even if the proceeds are paid directly to a beneficiary. However, if ownership of the policy was transferred to another individual or entity before death, the proceeds may not be included in the estate.

Business Interests

Ownership stakes in businesses, including closely held companies, partnerships, and corporations, are part of the estate's value. Valuing these interests can be complex and may require professional appraisals.

Personal Property

Tangible personal property, such as vehicles, jewelry, artwork, collectibles, and furniture, is included in the estate. The fair market value of these items at the time of death is used for estate tax purposes.

Trust Assets

Assets held in certain types of trusts, especially those over which the deceased had control or retained certain rights until death, may be included in the estate's taxable value.

Gifts Made Within Three Years of Death

Gifts made within three years before death can be pulled back into the estate for tax purposes, particularly if they were made as part of a strategy to reduce the estate's value below the taxable threshold.

Debts and Deductions

While calculating the estate's taxable value, allowable deductions, including debts owed by the deceased, funeral expenses, administrative costs, and bequests to qualifying charities, can reduce the overall taxable estate.

What Is the Estate Tax Rate?

The estate tax rate in the United States is a progressive tax rate applied to the portion of an estate that exceeds certain exemption thresholds set by federal and, in some cases, state governments. Understanding the estate tax rate is essential for effective estate planning and for executors tasked with managing the financial obligations of a deceased individual's estate.

Federal Estate Tax Rate

As of the most recent tax laws, the federal estate tax rate ranges from 18% to 40%. The exact rate applied to an estate depends on the estate's value that exceeds the federal exemption limit. For estates that qualify for taxation (those above the exemption threshold), the rate starts at 18% for the smallest taxable estates and increases progressively up to 40% for the portion of an estate's value that exceeds the highest rate threshold.

Exemption Threshold: The federal estate tax exemption amount is adjusted periodically for inflation. For example, in 2024, the federal exemption limit was $13.61 million for individuals, meaning that estates valued at or below this amount were not subject to federal estate taxes. Married couples can combine exemptions under certain conditions, effectively doubling the exemption amount.

Rate Application: The progressive rates apply only to the value of the estate exceeding the exemption amount. For instance, an estate valued at $14 million would only have its value above $13.61 million subjected to the escalating tax rates.

State Estate Tax Rates

In addition to federal estate taxes, some states impose their own estate taxes, with rates and exemption thresholds that vary by state. State estate tax rates are generally lower than the federal rate and can range widely, with some states applying flat rates and others adopting progressive rate structures similar to the federal system.

Exemption Thresholds: State-level exemptions are typically lower than the federal exemption, meaning estates might owe state estate taxes even if they are exempt from federal estate taxes.

Tax Application: Like the federal tax, state estate taxes usually apply only to the portion of an estate's value that exceeds the state's exemption amount.

Which States Have an Estate Tax?

The inheritance tax IRS officials impose has nothing to do with state estate taxes. Some states impose estate taxes, while some impose inheritance tax.

Both estate and inheritance tax: Maryland

Estate tax: Connecticut District of Columbia Illinois Maine Massachusetts Minnesota New York Oregon Rhode Island Vermont Washington Inheritance tax: Iowa Kentucky Nebraska New Jersey Pennsylvania

Estate Tax vs Inheritance Tax: What’s the Difference?

Estate tax and inheritance tax are two distinct forms of taxation that apply to the assets transferred upon someone's death, but they differ significantly in terms of who is responsible for the payment and how the taxes are assessed.

Estate Tax: Often dubbed the "death tax," it is levied on the total value of the deceased person's estate before the assets are distributed to the beneficiaries. It's a federal tax, with some states also imposing their own estate taxes, and is paid out of the estate itself, reducing the amount that eventually passes to the heirs. The rate at which estate tax is applied depends on the total value of the estate, with higher-value estates subject to higher tax rates, after accounting for any applicable exemptions.

Inheritance Tax: Imposed directly on the beneficiaries who receive assets from the estate. Not all states have an inheritance tax, but in those that do, the rate can vary depending on the beneficiary's relationship to the deceased, with closer relatives often paying a lower tax rate or being exempt entirely. This means that, under inheritance tax laws, the amount each beneficiary owes in taxes can differ based on their individual inheritance and their relationship to the deceased.

Understanding the differences between these taxes is crucial for effective estate planning and for beneficiaries to anticipate their potential tax liabilities.

How to Reduce or Avoid Federal Estate Tax

Wealthier taxpayers can help reduce the tax burden heirs will face. This starts with first using an estate tax calculator to determine what the liability will be. You can then give away assets or set up a trust that isn’t subject to the taxes. In some cases, a family limited partnership can also help reduce tax liability on an estate.

Final Thoughts

As you’re doing your estate planning, pay close attention to the current exemption rates. The 2024 estate tax exemption might be different from what that exemption is today. The best way to ensure your loved ones won’t have a tax burden is to work with a certified financial planner as you work on your estate planning.

Frequently Asked Questions

What is estate tax?

Estate tax, sometimes known as the "death tax," is a tax on the transfer of the deceased person's estate before distribution to the heirs. It's calculated based on the net value of all the assets owned at the time of death, including cash, real estate, investments, and other personal property, after deducting liabilities and exemptions.

Who has to pay estate tax?

The estate tax is levied on the estate of the deceased, not the beneficiaries. It's the responsibility of the executor of the estate to file an estate tax return and pay any taxes due from the estate's assets.

Is there a federal estate tax in the United States?

Yes, the United States imposes a federal estate tax on estates exceeding certain exemption thresholds. The rate is progressive, depending on the size of the estate.

What is the exemption threshold for federal estate tax?

The exemption threshold for the federal estate tax can change due to legislative updates or inflation adjustments. As of the last update, for 2024, the federal estate tax exemption was $13.61 million for individuals, meaning estates valued below this amount are not subject to federal estate tax.

Are estate taxes and inheritance taxes the same?

No, estate taxes and inheritance taxes are different. The estate tax is charged against the entire estate, while inheritance tax (where applicable) is levied on the beneficiaries receiving assets from the estate. Not all states impose an inheritance tax.

Do all states have an estate tax?

No, not all states impose an estate tax. Some states have their own estate tax in addition to the federal estate tax, often with different exemption thresholds and rates.

How are estate taxes calculated?

Estate taxes are calculated by determining the total value of the deceased's estate, subtracting any debts, and applying deductions for funeral expenses, charitable donations, and transfers to a surviving spouse. The net value is then subject to the applicable tax rate.

Can estate taxes be avoided or minimized?

Yes, there are strategies to minimize estate taxes, such as gifting assets during one's lifetime, establishing trusts, or making charitable donations. Proper estate planning with a professional can help reduce the estate tax burden.

What is the deadline for filing estate tax returns?

Generally, estate tax returns (Form 706) must be filed within nine months of the deceased person's death. However, an extension of up to six additional months can be requested.

Where can I get help with estate tax planning?

Estate tax planning can be complex, involving various legal and financial considerations. It's advisable to consult with estate planning attorneys, tax professionals, or financial advisors who specialize in estate planning to navigate the process effectively and ensure compliance with tax laws.