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Estate Tax vs. Inheritance Tax: What Your Heirs Need to Know
When someone passes away, the money and property they leave behind can be subject to different types of taxes. Two terms that are often confused are “estate tax” and “inheritance tax.” They sound similar, but they work differently and can have very different effects on what heirs actually receive.
In this article you’ll find clear explanations, practical examples, and a simple checklist heirs and executors can use right away. We’ll use realistic figures and walk through sample scenarios so you can see how taxes are calculated and what strategies people commonly use to reduce exposure.
What is an estate tax?
The estate tax is a tax on the total value of a deceased person’s estate before assets are distributed to heirs. In the United States, the federal government levies an estate tax when the estate’s value exceeds a set exemption amount. The tax is paid out of the estate itself, typically by the executor, and is calculated on the gross estate minus allowable deductions.
Key points about the federal estate tax:
- The federal exemption amount for 2024 is $13,610,000 per individual. That means most estates are not subject to federal estate tax.
- The top federal estate tax rate is 40% on the portion of the estate above the exemption.
- The estate tax is assessed on the estate, not on each individual heir.
- Filing an estate tax return (Form 706) may be required even when no tax is due, for example to elect portability of a deceased spouse’s unused exemption.
“Estate tax applies to the transfer of the whole estate, so an executor handles it before heirs receive distributions. That’s why having liquidity—cash or insurance—is so important to avoid forced sales of assets,” explains Elizabeth Carter, an estate planning attorney with 20 years’ experience.
What is an inheritance tax?
An inheritance tax, by contrast, is a tax that may be imposed on the individual who receives property. Inheritance taxes are assessed by some states, not by the federal government, and rates and exemptions vary by jurisdiction and by relationship (spouse, child, sibling, friend).
Key characteristics of inheritance tax:
- Who pays the tax? The heir pays it, not the estate (unless the will directs the estate to pay the tax).
- Rates often depend on the heir’s relationship to the deceased. Spouses are commonly exempt in many states; siblings or unrelated beneficiaries may pay higher rates.
- Only certain states impose inheritance taxes; the majority of states do not.
“Because inheritance taxes fall on beneficiaries, they can be surprising. Executors should identify potential state filing requirements early and communicate with heirs so everyone understands possible tax bills,” says Robert Lin, a tax attorney who advises families on probate matters.
Quick comparison: estate tax vs. inheritance tax
| Feature | Estate Tax | Inheritance Tax |
|---|---|---|
| Who levies it | Federal (and some states) | Some states only |
| Who pays | Estate (executor pays) | Individual heir |
| Primary basis | Total estate value | Amount received by each heir |
| Typical rates (U.S.) | Federal top rate 40%; exemption $13,610,000 (2024) | Varies by state and relationship — can be 0%–18% or more |
Federal estate tax in numbers (2024)
Below is a focused, accurate snapshot for federal estate tax rules as of 2024.
| Item | Value |
|---|---|
| Federal estate tax exemption (single, 2024) | $13,610,000 |
| Top federal estate tax rate | 40% |
| Portability | A surviving spouse can elect to use a deceased spouse’s unused exemption by filing an estate tax return (Form 706). |
Example scenarios: how the numbers play out
Numbers help. The table below shows three estate-size scenarios to illustrate how federal estate tax and a hypothetical state-level inheritance tax might affect the net amount heirs receive. For the inheritance tax in these examples we’ll assume a flat 10% charged to heirs (the actual rate and rules depend on the state and relationship).
| Estate value | Federal estate tax | State inheritance tax (10%) | Net to heirs |
|---|---|---|---|
| $1,000,000 | $0 (below federal exemption) | $100,000 | $900,000 |
| $5,000,000 | $0 (below federal exemption) | $500,000 | $4,500,000 |
| $20,000,000 |
Taxable amount = $20,000,000 − $13,610,000 = $6,390,000 Federal tax (40%) = $2,556,000 |
$2,000,000 | $15,444,000 |
Note: These examples use a simplified inheritance tax rate for illustration. Many states use tiers and exemptions so actual heir-level tax bills will vary. The federal estate tax only applies to the amount above the exemption and is calculated on the estate before distributions.
Common strategies to reduce estate and inheritance tax exposure
Families and advisors use several proven techniques to reduce taxes and preserve wealth for heirs. These strategies should be tailored to your situation with help from a qualified attorney or tax advisor.
- Use lifetime gifting: The annual gift tax exclusion in 2024 is $18,000 per recipient. Making gifts during lifetime reduces the taxable estate.
- Make charitable gifts: Charitable contributions reduce the taxable estate, and donor-advised funds can provide flexibility.
- Set up trusts: Irrevocable trusts (like an Irrevocable Life Insurance Trust) can remove assets from the taxable estate and provide liquidity for taxes.
- Consider a credit shelter (bypass) trust: Married couples often use this to maximize both spouses’ exemptions and shelter assets.
- Purchase life insurance strategically: Life insurance can provide the cash heirs need to pay taxes and settle the estate without selling illiquid assets.
- Plan for portability: Filing an estate tax return for the deceased spouse may preserve unused exemption for the surviving spouse.
- Review beneficiary designations: Retirement accounts (IRAs, 401(k)s) pass by beneficiary designation and can have income tax consequences for heirs. Roth IRAs work differently from traditional IRAs.
“Proactive planning is the best tax strategy. Many families think they can wait until the end, but a few steps taken years earlier—gift planning, coordinated beneficiary designations, and an appropriate trust—can save millions,” advises Jane Morales, a certified financial planner.
Practical tips for heirs and executors
When you’re named an executor or an heir, the first weeks and months after a death are busy and emotional. Here are practical steps to handle taxes and avoid surprises:
- Obtain multiple copies of the death certificate early (you’ll need them for banks, insurers, and government filings).
- Locate the will and key documents: trust agreements, life insurance policies, prior tax returns, beneficiary designations.
- Talk to an estate attorney or accountant before distributing assets—some distributions can change tax obligations or remove eligibility for exemptions.
- Determine whether a federal estate tax return (Form 706) is required. Even if no tax is due, filing may be necessary to elect portability.
- Check state rules: find out if the state where the deceased lived (or where property is located) has estate or inheritance taxes.
- Plan liquidity: if the estate includes real estate or closely-held business interests, discuss options to pay any tax bills without forced sales (insurance, installment agreements, loans).
Common questions heirs ask
Here are answers to several common questions heirs typically have.
Will the government take everything if the estate is large?
No. Even for very large estates, the top federal rate (40%) applies only above the exemption. Many estates also reduce tax liability through deductions, credits, and planning strategies. Additionally, state taxes apply only in certain jurisdictions and at varying rates.
Does a surviving spouse always pay no tax?
Spouses are generally exempt from inheritance tax in many states and transfers to a spouse are unlimited at the federal level (the marital deduction). However, to maximize the use of both spouses’ federal exemptions after one spouse dies, executors often elect portability on a timely-filed Form 706.
How do beneficiary-designated accounts (IRAs, 401(k)s) interact with estate and inheritance tax?
Retirement accounts pass by beneficiary designation and are included in the decedent’s estate for estate tax purposes if the decedent retained incidents of ownership. Even if not subject to estate tax, inherited retirement accounts can create income tax obligations for non-spouse beneficiaries. Roth IRAs generally generate tax-free distributions for beneficiaries but are still subject to estate or inheritance taxes as part of the estate’s value.
What about the “step-up” in basis?
When assets with appreciated value (like stocks or real estate) pass at death, heirs generally receive a step-up in basis to the fair market value at the decedent’s date of death. That can reduce capital gains if the heirs sell the asset. Estate tax rules are separate from basis rules, so even if the estate isn’t large enough to owe estate tax, heirs might receive valuable tax-basis benefits.
When should you get professional help?
If the estate is close to or above the federal exemption, owns a business, owns real estate in multiple states, includes complex investments, or if heirs live in different states, get professional advice early. A coordinated team—an estate attorney, tax attorney, and financial planner—can prevent mistakes that are hard or impossible to unwind.
Sample checklist for heirs and executors
- Secure and review the decedent’s will and trust documents.
- Collect death certificates (6–12 copies recommended).
- Identify and notify beneficiaries, banks, and insurers.
- Determine whether Form 706 (estate tax return) must be filed within nine months of death (with a possible six-month extension).
- Assess state-level estate or inheritance tax requirements and deadlines.
- Inventory assets and get valuations for significant holdings (real estate, business interests, stock positions).
- Review beneficiary designations on retirement accounts and life insurance.
- Plan liquidity for taxes and debts.
- Consult professionals before making major distributions.
Real-life example: How planning changed outcomes
Consider a married couple with combined assets of $25 million, largely in stock and real estate. Without planning, when the first spouse dies, the surviving spouse’s estate could exceed the single exemption and be subject to estate tax at the second death.
With planning, they might:
- Create a credit shelter trust funded up to the federal exemption ($13.61M in 2024) to shelter that amount from being included in the surviving spouse’s estate.
- Use portability by filing Form 706 when the first spouse dies to preserve any unused exemption for the survivor.
- Use life insurance in an irrevocable trust to provide liquidity to pay any future estate taxes rather than selling appreciated assets.
“Most families can significantly reduce eventual estate tax exposure by combining common-sense gifting, trust planning, and appropriate insurance coverage,” says Elizabeth Carter.
Final thoughts
Estate tax and inheritance tax are related but different. The estate tax is levied on the estate before distribution; inheritance tax, when applicable, is levied on the heirs. Most estates fall below the federal estate tax exemption in 2024 ($13,610,000) and owe no federal estate tax, but state-level taxes and income-tax consequences for heirs can still matter.
Start by collecting documents and talking to an experienced estate attorney or tax professional who understands the laws where the decedent lived and where major assets are located. Early, careful planning can preserve wealth for heirs, reduce tax surprises, and make the administration of an estate far less stressful.
Resources to mention to your advisor
- Ask whether portability of a deceased spouse’s unused exemption has been elected (Form 706).
- Request an inventory and valuations for major assets to confirm whether an estate tax return is needed.
- Discuss whether trusts (irrevocable trusts, credit shelter trusts) are appropriate for your family’s goals.
- Explore life insurance strategies for liquidity.
If you’d like, I can help you draft a one-page summary to take to your attorney that lists assets, beneficiaries, and the key questions to ask about estate and inheritance tax for your state. Just tell me which state (or states) are relevant and a rough inventory of assets and I’ll create the summary for you.
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