When someone dies, their estate and inheritances from it become subject to taxation, at least in theory. In reality, the vast majority of estates are too small to be charged federal estate tax, which applies only if the assets of the deceased person are worth $11.4 million or more. And most states have neither an estate tax, which is levied on the estate itself, nor an inheritance tax, which is assessed against those who receive an inheritance from an estate.
Indeed, the number of jurisdictions with such levies has been dropping, as political opposition has risen to what some criticize as "death taxes." That said, a dozen states plus the District of Columbia continue to tax estates and a half-dozen also levy inheritance taxes. Maryland collects both.
As with federal estate tax, these state taxes are collected only above certain thresholds. And even at or above those levels, your relationship to the decedent—the person who died—may spare you from some or all inheritance tax. Notably, surviving spouses and descendants of the deceased rarely if ever pay this levy.
It's relatively uncommon, then, for estates and inheritances to actually be taxed. Still, it's helpful to know more about the various taxes associated with these assets, and who needs to pay them and when.
- Only estates valued at $11.4 million or more are subject to federal estate tax
- A dozen states impose their own estate taxes and six have inheritance taxes. These levies kick in at lower threshold amounts than the federal estate tax
- 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
For tax purposes, these levies, both federal and state, are assessed on the estate's fair market value, rather than what the deceased originally paid for its assets. While that means any appreciation in the estate's assets over time will be taxed, it also protects against being taxed on peak values that have since dropped. For example, if a house was bought at $5 million but its current market value is $4 million, the latter amount will be used.
Anything in 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 one another is known as the unlimited marital deduction. However, when the surviving spouse who inherited an estate dies, the beneficiaries may then owe estate taxes if the estate exceeds the exclusion limit.
Other deductions, including charitable donations or any debts or fees that come with the estate, are also not included in the final calculation.
As with income tax, estate tax is applied only to the sum that exceeds the exemption. So if your estate was valued at $6 million, and the state's exempt amount was $3.6 million, taxes would be assessed on the difference of $2.4 million, not on the full value of the estate.
Federal Estate Tax
As of 2019, the Internal Revenue Service (IRS) requires estates with combined gross assets and prior taxable gifts exceeding $11.4 million to file a federal estate tax return and pay the relevant estate tax. For the two years prior, 2017 and 2018, the return was required, and taxes potentially owed, if the estate exceeded $5.49 million and $11.18 million, respectively.
The portion of the estate that's above that $11.4 million threshold will ostensibly be taxed at the top federal statutory estate tax rate of 40%. In practice, however, various discounts, deductions, and loopholes allow skilled tax accountants to pare 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
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 $1,000,000.
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, with the threshold minimums at which they apply shown in parentheses. Click on the state's name for further information from the state government on its estate tax.
Above those thresholds, tax is usually assessed on a sliding basis, much like the brackets for income tax. The tax rate is typically 10% or so for amounts just over the threshold, and rises in steps, usually to 16%. The tax is lowest in Connecticut, where it begins at 7.80% and rises to 12%, and highest in Washington State, where it tops out at 19%.
The maximum rate for inheritance tax charged by any state
State Inheritance Tax
There's no federal inheritance tax, but select states (as of 2019, 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 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, although life insurance payable to the deceased person or to his 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. Above those thresholds, tax is usually assessed on a sliding basis. Rates typically begin in the single digits and rise to between 15% and 19%. 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.
As a rule, the closer your relationship to 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 inheritor is living.
Here are the jurisdictions that have inheritance taxes, with their threshold minimums shown in parentheses. Click on the state's name for further information on its inheritance tax from the state government.
Plan Now for Taxes on Estates
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.
Monitor any changes to the laws that affect you, perhaps by setting online news alerts around the state relevant to you and the terms "estate taxes" and "inheritance taxes." As you grow older, you can help prepare your loved ones for taxes by explaining the laws to them. You might even want to set aside a fund to help offset that tax burden when it comes.
Consider, too, 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 it.