How to Work Out Inheritance Tax on an Estate

The federal estate tax is levied on the transfer of a person’s assets to their heirs after death. It is a tax on the estate itself, not on the individuals receiving the assets. The calculation involves determining the total value of the deceased’s assets, subtracting debts and expenses, and applying exemptions and allowances to find the final taxable amount.

Step 1 Valuing the Estate

The initial step is to calculate the total value of everything the deceased person owned, known as the “gross estate.” This accounting must use the fair market value of each asset as of the date of death, not the original purchase price. The estate’s executor can elect an “alternate valuation date,” which is six months after the date of death, if doing so would decrease both the gross estate’s value and the tax owed. This election, under Internal Revenue Code Section 2032, must be applied to all assets.

A professional valuation is necessary for assets like homes, land, or other real estate to determine their fair market value. Financial assets, such as money in bank accounts and stocks, are valued based on their stated worth on the date of death. Interests in a private business may require a specialized business valuation.

Personal possessions like vehicles, jewelry, artwork, and furniture also contribute to the gross estate’s value. While a reasonable estimate may work for everyday household items, high-value collections or individual items often require a formal appraisal by a qualified expert.

How an asset is owned affects its valuation. For assets owned as “joint tenants with rights of survivorship” with a spouse, half of the asset’s value is included in the estate. If the joint owner is not a spouse, the included portion is proportional to the deceased’s contribution. For assets held as “tenants in common,” only the decedent’s specific share is included.

The valuation must also account for certain gifts made before death. The U.S. has a unified estate and gift tax system, meaning taxable gifts made during a person’s lifetime reduce the exemption available at death. The annual gift exclusion for 2025 is $19,000 per recipient. Gifts exceeding this amount are considered taxable and are factored into the final estate tax calculation.

Step 2 Accounting for Debts and Liabilities

After determining the gross value of the estate, the next step is to identify and subtract all permissible debts and liabilities. This process reduces the gross estate value to arrive at the “adjusted gross estate.” These deductions must be legitimate obligations of the decedent at the time of their death.

Commonly deducted debts and expenses include:

• Outstanding mortgages on real estate and other secured or unsecured loans.
• Credit card balances and any bank overdrafts.
• Unpaid household bills, such as utilities and property taxes.
• Unpaid income taxes for the year of death or prior years.
• Reasonable funeral expenses, including costs for the service, burial or cremation, and a monument.
• Administration expenses incurred in settling the estate, such as executor’s fees, attorney’s fees, and appraisal costs.

Step 3 Applying Exemptions and Reliefs

Once the net value of the estate is determined by subtracting debts from the gross value, certain assets may still be shielded from tax through specific exemptions and reliefs. These provisions can substantially reduce the portion of the estate subject to tax.

The most used exemption is for transfers to a surviving spouse. Any asset that passes to a surviving spouse who is a U.S. citizen is exempt from estate tax under the unlimited marital deduction. This allows for the tax-free transfer of wealth between spouses, deferring potential estate tax until the surviving spouse’s death.

Another exemption applies to assets left to qualified charitable organizations. Any bequest made to a registered charity as defined by the IRS is fully deductible from the estate.

For estates that include a family-owned farm or a closely held business, a special valuation method may be available. Under Section 2032A, certain real property can be valued based on its actual use rather than its higher fair market value. This “special use valuation” is intended to help prevent the forced sale of a farm or business to pay estate taxes.

Step 4 Determining the Tax-Free Allowances

After applying specific exemptions and reliefs, the next step is to utilize the main tax-free allowances available to most estates. These allowances set a threshold, and only the value of the estate exceeding this threshold is subject to tax.

The Basic Exclusion Amount (BEA) is the amount an individual can transfer tax-free during their life or at death. For 2025, the federal BEA is $13.99 million per individual and is indexed for inflation annually.

A feature of the estate tax system is “portability,” which allows a surviving spouse to use any unused portion of their deceased spouse’s BEA. This is known as the Deceased Spousal Unused Exclusion (DSUE) amount. To secure this benefit, the executor of the first spouse to die must file an estate tax return to report the unused amount, even if no tax is due. This can effectively double the tax-free allowance for a married couple to a combined $27.98 million in 2025.

For example, if a husband dies and his estate uses only $4 million of his $13.99 million exclusion, the remaining $9.99 million is portable. His surviving wife can add this DSUE amount to her own exclusion. This gives her a total exclusion of $23.98 million ($13.99 million of her own plus the $9.99 million DSUE).

The Tax Cuts and Jobs Act of 2017, which increased the BEA, is set to expire at the end of 2025. If no legislative action is taken, the BEA is scheduled to revert to its pre-2018 level of approximately half the current amount, adjusted for inflation.

Step 5 Calculating the Final Tax Liability

The final calculation begins with the net estate value, which is the gross estate minus total debts and administrative expenses. From this amount, you subtract the value of any assets covered by specific exemptions, such as the marital or charitable deductions. The result is the value of the estate before applying the general tax-free allowances.

Next, you subtract the total available Basic Exclusion Amount (BEA) and any Deceased Spousal Unused Exclusion (DSUE) amount. The resulting figure is the final taxable estate.

The federal estate tax is then applied to this final taxable value at a flat 40% rate. For instance, if the final taxable value of an estate is $1 million, the estate tax liability would be $400,000. This calculation is reported on Form 706, the U.S. Estate (and Generation-Skipping Transfer) Tax Return.