Inheritance tax: How it works and how it differs from estate tax

Yahoo

30-05-2025

An inheritance tax is levied when a beneficiary inherits assets from the estate of someone who died. There is no federal inheritance tax, but five states currently levy this tax: Kentucky, Maryland, Nebraska, New Jersey and Pennsylvania. (Iowa was a sixth state on that list until it ended its inheritance tax starting in 2025.)
The federal government does levy an estate tax, as do 12 states and Washington, D.C. Maryland is currently the only state to assess both an estate and an inheritance tax.
Unlike an estate tax, which is paid by the estate before the assets are distributed, an inheritance tax is paid by the beneficiary on the assets' value. The tax is levied if the person who died lived in a state that has an inheritance tax, even if the beneficiary lives in a state without an inheritance tax.
The inheritance tax rate, as well as which assets it applies to and which beneficiaries must pay it, varies by state. Each state has its own rules (more on that below).
In states with an inheritance tax, beneficiaries pay a tax on the value of their inheritance. Often, the inheritance tax is a progressive tax, which means the tax rate increases with the value of the bequest. (A progressive tax system employs a series of tax rates, whereas a flat tax system generally uses one tax rate for all income levels.)
Some states assess different tax rates depending on the asset received, or the beneficiary's relationship to the person who died. Close relatives may be exempt from the inheritance tax, or may pay a lower rate. State laws vary and are subject to change.
In 2024, the highest inheritance tax rate among the five states (remember, states usually levy a range of inheritance tax rates) ranged from 10 to 16 percent, with New Jersey and Kentucky having the highest top tax rate of 16 percent, according to a report by the Tax Foundation.
Some states, including Nebraska, New Jersey and Maryland offer an inheritance tax exemption, which allows the beneficiary to avoid the inheritance tax if the asset's value is less than the exemption amount. For example, in Nebraska, immediate relatives are given a $100,000 exemption — that is, close relatives pay a 1 percent tax on the value of inherited assets exceeding $100,000.
In New Jersey, spouses, domestic partners, children and grandchildren are exempt from paying inheritance taxes. Some beneficiaries, including siblings of the person who died, pay inheritance tax rates of 11 to 16 percent after a $25,000 exemption. Other beneficiaries, including aunts, uncles and cousins, pay rates of 11 to 16 percent on the entire inheritance, without the benefit of an exemption amount.
Maryland offers an inheritance tax exemption for property worth less than $1,000; the state also exempts surviving spouses, children, grandchildren, great-grandchildren, parents and grandparents from paying an inheritance tax.
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In 2025, five states impose an inheritance tax:
Kentucky
Maryland
Nebraska
New Jersey
Pennsylvania
The highest inheritance tax rates range from 10 percent in Maryland to a high of 16 percent in Kentucky and New Jersey. Until 2025, Iowa had the lowest rate: 2 percent. However, Iowa abolished its inheritance tax, starting in 2025; beneficiaries won't pay inheritance taxes in Iowa beginning Jan. 1, 2025.
It's easy to confuse the inheritance tax with the estate tax, but the two are quite different. The inheritance tax is imposed on the individual who inherits assets from someone else. An estate tax is imposed directly on the decedent's estate before the assets are distributed to beneficiaries.
The federal government imposes an estate tax of 18 to 40 percent on assets above a specific exemption amount. That amount is $13.6 million in 2024, and almost $14 million in 2025.
In addition to the federal government, 12 states and the District of Columbia charge a state estate tax. For this reason, some estates pay both a federal and state estate tax. Like the federal government, states that have an estate tax generally offer an exemption amount. In 2024, state estate tax exemption amounts ranged from $1 million in Oregon to $13.6 million in Connecticut, according to the Tax Foundation.
In addition to the District of Columbia, these 12 states impose an estate tax:
Connecticut
Hawaii
Illinois
Maine
Maryland
Massachusetts
Minnesota
New York
Oregon
Rhode Island
Vermont
Washington
While beneficiaries have limited options for reducing taxes after receiving an inheritance, they should check state rules to see if they qualify for any exemptions that would help them reduce or avoid the tax altogether.
However, those who plan to leave an inheritance to loved ones should consider the following strategies to reduce or avoid inheritance tax for their beneficiaries.
Take advantage of the annual gift tax exclusion, which allows you to transfer wealth while you're still alive, without paying taxes. For 2025, the annual gift tax exclusion is $19,000 per recipient (up from $18,000 in 2024). In 2025, individuals can gift $19,000 to as many people as they choose without triggering the need to file a gift tax return. If you're married, each spouse can gift $19,000. For example, in 2025, a couple with four children can gift a total of $152,000 to their children ($19,000 per spouse to each child) without triggering the gift-tax-return requirement. If you exceed that annual limit for any one beneficiary, it's likely you'll need to file a gift tax return, Form 709, with your Form 1040. (And married couples, especially, should consider consulting with a tax professional when employing a 'gift splitting' strategy.) But keep in mind that you still won't owe gift taxes unless you exceed your individual lifetime estate and gift tax exemption, which currently is almost $14 million.
Another way to avoid the inheritance tax is to choose to reside (or own property) in a state that doesn't impose the tax. Currently, five states impose an inheritance tax. Choosing to forego these states means you're helping your beneficiaries avoid the inheritance tax altogether. (Inheritance tax is levied based upon where the decedent lived.)
Meeting with an estate professional to create a plan to eliminate or reduce inheritance or estate taxes is wise. Making a plan can remove a heavy burden at the time of death.