When someone passes away and leaves behind money, property, or other assets, taxes may apply to the wealth being transferred. Depending on where you live and how much is being passed down, these taxes can significantly reduce what your heirs receive.
There are two main types:
- Estate tax is paid by the estate before assets are distributed.
- Inheritance tax is paid by the person who receives the assets.
While the federal government only imposes an estate tax, some states apply one or both types, each with different rules, rates, and exemptions.
Understanding how these taxes work and who they affect can help you make better decisions for your family and your legacy. With the right planning, it’s often possible to reduce or avoid these taxes altogether. I’ve seen how a few smart steps can make a big difference in what your loved ones actually receive.
What is Estate Tax?
Estate tax is a tax on the total value of someone’s assets after they pass away, but before those assets are given to their heirs. It’s sometimes called the “death tax.”
The tax is based on everything the person owned at the time of death. That includes:
- Cash
- Investments
- Real estate
- Business ownership
- Life insurance proceeds (if the policy was owned by the person who died)
The estate itself pays the tax, not the heirs. The executor or personal representative of the estate is responsible for handling it.
Estate tax doesn’t affect every family. It only applies if the estate is worth more than a certain amount. That amount depends on whether you’re looking at federal rules or your state’s rules. We’ll break down both so you know what to expect.
Federal Estate Tax
At the federal level, estate tax only applies to large estates.
In 2025, the estate tax exemption is $13.99 million per person. That means if someone dies with an estate worth less than that, no federal estate tax is owed.
For married couples, there’s a rule called portability. This allows the couple to combine their exemptions and protect more of their estate from federal tax.
If an estate is worth more than the exemption, the amount above the limit is taxed. The federal estate tax rate ranges from 18% to 40%, depending on how much over the limit the estate is.
To report and pay federal estate tax, the estate must file IRS Form 706. It’s due nine months after the person’s death, but the executor can request a six-month extension if needed.
Not every estate needs to file this form. It’s only required if there may be estate tax owed or if the family wants to carry over any unused exemption to a surviving spouse.
State Estate Tax
In addition to the federal estate tax, some states have their own estate tax. Even if your estate isn’t large enough to trigger a federal tax, you might still owe estate tax at the state level.
These states (and D.C.) impose a separate estate tax:
- Connecticut
- District of Columbia
- Hawaii
- Illinois
- Maine
- Maryland
- Massachusetts
- Minnesota
- New York
- Oregon
- Rhode Island
- Vermont
- Washington
Each state sets its own exemption amount and tax rate. Most are much lower than the federal exemption, which means more families are more likely to get caught in the net.
If you live in one of these states and have over $1 million in assets, it makes sense to start planning now. A little preparation can go a long way in helping your family avoid unnecessary taxes down the line.
What is Inheritance Tax?
Inheritance tax is a tax paid by the person who receives the inheritance, not the estate itself.
That’s an important difference.
The amount of inheritance tax someone might owe depends on how much they receive and their relationship to the person who passed away.
For example, in states that impose this tax, spouses usually pay nothing, while distant relatives or unrelated heirs may pay a higher rate.
There’s no federal inheritance tax. Only a few states charge this tax, which we’ll look at next.
States That Impose an Inheritance Tax
Six states impose an inheritance tax:
- Iowa (phasing out completely by 2025)
- Kentucky
- Maryland
- Nebraska
- New Jersey
- Pennsylvania
Inheritance tax rules are different in each state, but they generally follow the same pattern. What someone owes depends on how much they inherit and how closely they were related to the person who passed away.
Spouses are almost always exempt. Children and grandchildren often pay little or nothing. But siblings, nieces, nephews, or unrelated heirs may owe more.
Maryland is unique. It’s the only state that charges both an estate tax and an inheritance tax. That can be a costly combination for larger estates with distant heirs.
If you or your heirs live in one of these six states, it’s worth taking a closer look at how the rules might affect your plans.
How Beneficiaries Are Taxed Differently
Inheritance tax doesn’t treat everyone the same. Who you are to the person who passed away matters a lot.
Here’s how it usually works:
- Spouses are always exempt from inheritance tax in every state that has one.
- Children and grandchildren often get preferential treatment; either full exemption or very low rates.
- More distant relatives, like nieces, nephews, or friends, typically pay higher tax rates.
Each state sets its own rules, but in general, the more distant the relationship, the higher the tax.
Key Differences Between Estate and Inheritance Tax
Here’s a side-by-side look at the key differences between the two:
| Feature | Estate Tax | Inheritance Tax |
| Who pays | The estate | The beneficiary |
| Level | Federal + some states | State-only (6 states) |
| Applies to | Total estate value | Amount inherited |
| Based on | Value of all assets | Relationship to deceased |
Estate tax is taken out of the estate before heirs receive anything. Inheritance tax is paid by the person who inherits, and only in certain states. The two are separate and can sometimes apply at the same time, depending on where you live and how much you’re passing down.
How to Reduce or Avoid Estate and Inheritance Taxes
If your estate might be affected by these taxes, there are ways to reduce the impact or even avoid them altogether.
Here are a few strategies we often discuss with clients:
Ways to Reduce Estate Tax
- Lifetime gifting: In 2025, you can give up to $19,000 per person per year without using up your lifetime exemption. This helps move money out of your estate over time.
- Use of irrevocable trusts: Certain types of trusts can move assets out of your taxable estate.
- Charitable giving: Donations to qualified charities reduce the taxable size of your estate and support causes you care about.
- Spousal portability: If one spouse dies without using their full exemption, the surviving spouse can carry it forward. This effectively doubles the amount that can pass to heirs without being taxed.
- Strategic life insurance planning: Life insurance owned by an ILIT won’t be included in your estate, which can help cover estate tax bills without creating a new one.
I’ve helped many clients implement these strategies over my career, and when done properly, they can significantly reduce tax exposure.
Tips for Managing Inheritance Tax
- Relocating or shifting ownership: If your heirs live in a state that taxes inheritances, it may be worth reviewing where assets are held and how they’re passed down.
- Beneficiary designations: Make sure your retirement accounts, life insurance, and other transfer-on-death assets are set up properly. These avoid probate and can help direct assets more efficiently.
- Asset titling: The way you own property, whether jointly, individually, or in a trust, can affect how and when taxes come into play.
These strategies can make a meaningful difference, but every situation is unique. If you’re thinking about your estate or worried about what your heirs might owe, it’s a good idea to talk with a qualified advisor.
We help our clients understand their options and build plans that align with their values, their families, and the tax laws that apply.
Examples of How These Taxes Work
Sometimes the best way to understand these taxes is to see how they play out in real life.
Estate Tax Example (Federal)
Let’s say someone dies in 2024 with an estate worth $15 million.
- The federal exemption was $13.61 million
- That leaves $1.39 million taxable
- At a top tax rate of 40%, the estate could owe around $556,000 in federal estate tax
The estate would pay this amount before passing any assets to heirs.
Inheritance Tax Example (Pennsylvania)
Now imagine a nephew in Pennsylvania inherits $500,000.
- Pennsylvania taxes inheritances from nieces and nephews at 15%
- That means the nephew owes $75,000 in inheritance tax
He pays this tax personally, out of what he received.
How to Plan for Estate or Inheritance Tax
Planning early is a smart way to deal with estate and inheritance taxes.
Good planning isn’t just about avoiding taxes. It’s about making sure your legacy reaches the people and causes you care about, the way you intend.
We help clients think through the full picture when it comes to estate and inheritance taxes. That includes:
- Estate planning needs analysis to identify potential tax exposure
- Tax planning coordination with your CPA or attorney
- Trust and beneficiary structure
If you’re not sure whether these taxes apply to you, or you want to reduce their impact on your legacy, schedule a consultation to start the conversation.