Few topics generate more confusion and anxiety than taxes after death. People worry that their heirs will lose a significant portion of their estate to taxes — but for most families, that fear is much larger than the actual tax bill. Here's what the rules actually say.
Two Different Taxes: Estate Tax vs. Inheritance Tax
These terms are often used interchangeably, but they're legally distinct:
Estate tax
The estate tax is levied on the estate itself — before assets are distributed to heirs. If the estate owes estate tax, the executor pays it from estate assets before anyone inherits anything. Both the federal government and some states impose estate taxes.
Inheritance tax
The inheritance tax is levied on the person receiving the inheritance, not on the estate itself. The federal government does not have an inheritance tax. Only six states have inheritance taxes: Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. Maryland has both estate and inheritance taxes — the only state that does.
Federal Estate Tax: Who Pays It?
Almost no one, in practice. The federal estate tax only applies to estates above the federal exemption:
- 2024 exemption: $13.61 million per person
- Married couples: $27.22 million (using portability — the surviving spouse can use the deceased spouse's unused exemption)
- The tax rate on amounts above the exemption is 40%
By any measure, the vast majority of American estates — well over 99% — never owe federal estate tax. If your estate is under $13.61 million, federal estate tax is not your concern.
The 2026 sunset
The current high exemption was established by the Tax Cuts and Jobs Act of 2017. Unless Congress acts, the exemption reverts to approximately $7 million per person (indexed for inflation) on January 1, 2026. For high-net-worth individuals, this is significant planning territory. For most families, it doesn't change much.
State Estate Taxes
Twelve states and Washington D.C. have their own estate taxes, often with lower exemptions than the federal level:
- Massachusetts and Oregon: $1 million exemption — these are the lowest in the country
- Washington state: $2.193 million
- Maryland: $5 million
- Illinois, Minnesota, New York: Various exemptions in the $2–$6 million range
- Other states with estate taxes: Connecticut, Hawaii, Maine, Rhode Island, Vermont
If you live in a state with an estate tax and your estate may approach the threshold, this should be part of your estate planning conversation.
State Inheritance Taxes
Six states have inheritance taxes. Key points:
- The rate and who pays typically depends on your relationship to the deceased
- Spouses are almost always exempt
- Children are often exempt or taxed at a low rate
- More distant relatives and non-relatives typically face higher rates
| State | Exempt relatives | Max rate |
|---|---|---|
| Iowa | Spouses, descendants, ancestors (phased out by 2025) | 6% |
| Kentucky | Spouses, children, grandchildren, parents | 16% |
| Maryland | Spouses, children, grandchildren, parents, siblings | 10% |
| Nebraska | Spouses, parents, children, grandchildren | 15% |
| New Jersey | Spouses, domestic partners, children, grandchildren, parents | 16% |
| Pennsylvania | Spouses, minor children (direct descendants pay 4.5%) | 15% |
Do You Pay Income Tax on an Inheritance?
In most cases, no. Inherited money and property is generally not considered income for federal income tax purposes. You don't report it on your Form 1040.
Exceptions:
- Inherited traditional IRAs and 401(k)s: Distributions from inherited retirement accounts are taxable as ordinary income because the original contributions were made pre-tax. The SECURE Act (2019) requires most non-spouse beneficiaries to withdraw all funds within 10 years.
- Inherited income in respect of a decedent (IRD): Income the deceased was entitled to but hadn't received before death — like final wages, accrued interest, or installment sale proceeds — is taxable to the recipient.
- Gains from selling inherited property: If you sell inherited property, you may owe capital gains tax — but often much less than you'd expect, due to the step-up in basis.
The Stepped-Up Basis: A Major Tax Advantage for Heirs
When you inherit an asset, its tax basis is "stepped up" to the fair market value at the date of death. This is one of the most valuable provisions in the tax code for heirs.
Example: Your grandfather bought stock for $10,000 in 1990. When he dies in 2024, it's worth $200,000. You inherit it. Your basis is $200,000 — not $10,000. If you sell it immediately for $200,000, you owe zero capital gains tax. If you sell it later for $225,000, you owe capital gains tax only on the $25,000 gain above your stepped-up basis.
Without the step-up, you would have owed capital gains tax on the entire $190,000 gain.
Planning Strategies for Larger Estates
If your estate may approach state or federal estate tax thresholds, several strategies can reduce exposure:
Annual gifting
You can give up to $18,000 per person per year (2024) to as many people as you like without using any of your lifetime exemption or owing gift tax. Over many years and to multiple recipients, this can significantly reduce a taxable estate.
Direct payments for tuition and medical expenses
Payments made directly to educational institutions for tuition, and directly to medical providers for medical expenses, are unlimited and don't count against the annual gift exclusion.
Charitable giving
Gifts to qualified charities reduce the taxable estate. Charitable remainder trusts, donor-advised funds, and charitable lead trusts can accomplish charitable goals while also providing tax benefits.
Irrevocable life insurance trusts (ILITs)
Life insurance death benefits are normally included in the estate. An ILIT removes the policy from your estate while still providing the death benefit to your heirs — potentially tax-free.
Work with professionals
These strategies are complex and the rules change frequently. If your estate may owe estate tax, work with an estate planning attorney and a CPA who specializes in estates.
What Most Families Actually Owe: Zero
If your estate is under the applicable thresholds — and most are — your heirs won't owe estate or inheritance taxes (unless they're in one of the six inheritance-tax states and are non-exempt relatives). The tax fears that delay estate planning for most families are significantly larger than the actual exposure.
The more pressing issue for most families isn't taxes — it's organization. Whether your heirs can find your accounts, know your wishes, and handle the practical challenges of settling an estate without a year of stress.