Money or property you inherit may be subject to estate taxes and inheritance taxes, but it's not likely. Most estates are not rich enough to qualify for the federal estate tax. The federal estate tax as of the 2023 tax year applies only on the value of an estate that exceeds $12.92 million. In 2024, the exemption rises to $13.61 million. Surviving spouses are exempt.
Moreover, most states have neither an estate tax, which is levied on the estate, nor an inheritance tax, which is assessed against the recipient of the inheritance.
A dozen states do levy estate taxes and six have inheritance taxes. All set their limits lower than the federal thresholds. The lowest thresholds are $1 million. The highest estate tax rates are 18%.
Key Takeaways
- The IRS sets limits on estate values before they are subject to taxation.
- A dozen states impose their own estate taxes, and six have inheritance taxes, both of which kick in at lower threshold amounts than the federal estate tax.
- Federal and most state taxes are assessed only on the value of the estate or inheritance that exceeds the threshold amount.
- Surviving spouses are generally exempt from these taxes, regardless of the value of the estate or inheritance.
- To minimize estate taxes, taxpayers whose estates are above the threshold can set up trusts to facilitate the transfer of wealth.
Estate Taxes: An Overview
Estate taxes, whether federal or state, are assessed on the estate's fair market value (FMV), not on the price the deceased paid.
That means any appreciation in the estate's assets over time will be taxed, but it protects those who inherit assets that have dropped in value. For example, if a house was bought at $5 million, but its current market value is $4 million, the latter amount will be used for tax purposes.
Any part of the estate that is bequeathed to a surviving spouse is not counted in the total amount and isn't subject to estate tax. The right of spouses to leave any amount to each other is known as the unlimited marital deduction.
When the surviving spouse who inherited an estate dies, the beneficiaries may then owe estate taxes if the estate's value exceeds the exclusion limit. Other deductions, including charitable donations or any debts or fees that come with the estate, are excluded from the final calculation.
Declining an Inheritance
An heir due to receive money or other assets can choose to decline the inheritance through the use of an inheritance or estatewaiver. The waiver is a legal document declining the rights to the inheritance.
In such an instance, the executor of the will would then name a new beneficiary of the inheritance.
An heir might choose to waive theirinheritance to avoid paying taxes or to avoid having to maintain a house or other structure. A person in a bankruptcy proceeding mightchoose to sign a waiver so that the property can't be seized by creditors.
State laws determine how the waivers work.
State Estate and Inheritance Taxes
The number of jurisdictions that have estate or inheritance taxes is declining, as opposition has risen to what some call death taxes.
That said, a dozen states plus the District of Columbia continue to tax estates, and a half dozen impose inheritance taxes. Maryland collects both.
As with federal estate tax, these state taxes are collected only above certain thresholds. Even at or above those levels, your relationship to the deceased may spare you from some or all inheritance tax.
Notably, surviving spouses and descendants of the deceased rarely, if ever, have to pay this tax.
40%
The top federal statutory estate tax rate in 2023.
Federal Estate Taxes
As noted above, theInternal Revenue Service (IRS) requires estates with combined gross assetsand prior taxable gifts exceeding $12.92 million to file a federal estate tax return and pay the relevant estate tax for the 2023 tax year.
The portion of the estate that’s above this $12.92 million limit in 2023 will be taxed at the top federal statutory estate tax rate of 40%. In practice, various discounts, deductions, and loopholesallow skilled tax accountants to reduce the effective rate of taxation to well below that level.
Among those techniques is to take advantage of flexibility over the valuation date of the estate in order to minimize the estate's value or cost basis.
State estate taxes are levied by the state in which the deceased was living at the time of death. Inheritance taxes are levied by the state in which the beneficiary lives.
State Estate Taxes
If you live in a state that has an estate tax, you’re more likely to feel its pinch than you are to pay federal estate tax. The exemptions for state and district estate taxes are all less than half those of the federal assessment. Some go as low, relatively speaking, as $1 million.
An estate tax is assessed by the state in which the decedent was living at the time of death.
Here are the jurisdictions that have estate taxes. Click on the state's name for further information from the state government on its estate tax.
- Connecticut
- District of Columbia
- Hawaii
- Illinois
- Maine
- Massachusetts
- Maryland
- New York
- Oregon
- Minnesota
- RhodeIsland
- Vermont
- WashingtonState
Tax is usually assessed on a sliding basis above these thresholds, much like the income tax brackets. The tax rate is typically about 10% for amounts just over the threshold, and it then rises in steps to about 16%.
The top estate tax rate is lowest in Connecticut, at 12%, and the highest is in Washington State, where it tops out at 20%.
18%
The maximum rate for inheritance tax charged by any state.
State Inheritance Taxes
There is no federal inheritance tax, but states including Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania still tax some assets inherited from the estates of deceased persons.
Whether your inheritance will be taxed (and at what rate) depends on its value, your relationship to the person who passed away, and the prevailing rules and rates where you live.
Life insurance payable to a named beneficiary is not typically subject to an inheritance tax, althoughlife insurancepayable to the deceased person or their estate is usually subject to an estate tax.
As with estate tax, an inheritance tax, if due, is applied only to the sum that exceeds the exemption. Tax is usually assessed on a sliding basis above those thresholds. Rates typically begin in the single digits and rise to between 15% and 18%.
Both the exemption you receive and the rate you’re charged may vary by your relationship to the deceased—more so than with the value of assets you are inheriting.
Inheritance Tax Exemptions
As a rule, the closer your relationship with the decedent, the lower the rate you'll pay.
Surviving spouses are exempt from inheritance tax in all six states. Domestic partners, too, are exempt in New Jersey. Descendants pay no inheritance tax except in Nebraska and Pennsylvania.
Inheritance tax is assessed by the state in which the person who inherits is living.
Spousal Benefits
Some states offer tax reductions for widows and widowers, such as a reduction in property taxes for a certain period of time. For example, in Florida, surviving spouses are entitled to receive a reduction in the taxable value of a property they own by $500 each year, in perpetuity or until they remarry.
Here are the jurisdictions that have inheritance taxes. Click on the state's name for further information on its inheritance tax from the state government:
Maximize Your Gifts
Maximizing your gifting potential is another way to reduce estate taxes. In 2023, the annual exclusion for gifts is up to $17,000.
How to Minimize Estate Taxes
Keep the planning simple and the total amount of the estate below the threshold to minimize estate taxes. For most families, that's easy. For those with estates and inheritances above the threshold, setting up trusts that facilitate the transfer of wealth can help ease the tax burden.
One way to reduce estate tax exposure is to use an intentionally defective grantor trust (IDGT), which is a type of irrevocable trust that allows a trustor to isolate certain trust assets to separate income tax from estate tax treatment on those assets. The grantor pays income taxes on any revenue generated by the assets but the assets can grow tax-free. This way, the grantor's beneficiaries can avoidgift taxation.
You can reduce your estate taxes if you own a life insurance policy as well. On their own, life insurance proceeds are income-tax-free at the federal level when they are paid to your beneficiary. But when the proceeds are included as part of your taxable estate for estate tax purposes, that might push your estate over the cutoff.
One way to make sure that doesn't happen is totransferownership of your policy to another person or entity, including the beneficiary. Another possibility is to set up anirrevocable life insurance trust (ILIT).
What Assets Are Subject to Estate Taxes?
All the assets of a deceased person that are worth $12.92 million or more in 2023 are subject to federal estate taxes. The amount is revised annually.
A number of states also charge estate taxes. Each state sets its own rules on exclusions and thresholds for taxation.
What Is the Estate Tax Rate?
On the federal level, the portion of the estate that surpasses $12.92 million in value will be taxed at a rate of 40%,as of the 2023 tax year.
States that tax estates have varying rules, but 18% is the federally-mandated maximum inheritance tax rate that can becharged by any state.
What Is the Difference Between an Estate Tax and an Inheritance Tax?
An estate tax is levied on the estate itself, while an inheritance tax is levied against the recipient of an inheritance from an estate.
When state taxes apply, any estate tax is paid to the state in which the deceased resided, while any inheritance tax is paid to the state in which the recipient of the inheritance lives.
Do I Have to Pay Taxes on an Estate?
If you receive an inheritance from an estate and the assets are worth more than $12.92 million in 2023, you will have to pay inheritance taxes on the amount above that level. The estate tax is levied on the estate itself.
How Can I Avoid Estate Taxes?
Methods used by the very wealthy to avoid estate taxes include setting up a trust, such as an intentionally defective grantor trust, which separates income tax from estate tax treatment. Also, a life insurance policy can be transferred so that it won't be counted as part of your estate. Strategic use of gifting is yet another tactic.
All of these strategies are best managed by a professional tax consultant to make sure they are done properly.
The Bottom Line
Inheritance taxes are complex and change frequently. Most of us engage with them during a stressful and busy period of our lives. It's wise to prepare for the inevitable by doing some homework in advance.
As long as the estate in question does not have assets exceeding $12.92 million as of the 2023 tax year, you will not owe federal estate or inheritance taxes. However, keep an eye on your state for their current rules since some charge estate taxes or inheritance taxes with lower thresholds.
Consider meeting with a lawyer, CPA, or CFP to begin planning your estate and minimizing the tax your beneficiaries will have to pay when they inherit.
