What Is the Difference Between Estate and Inheritance Tax?

When an individual passes away, wealth transfer taxes can impact the value of assets received by beneficiaries. These taxes are levied by governments on the transfer of property or money, especially upon death. Understanding these taxes is important for estate planning or inheriting assets. This article explores estate tax and inheritance tax, highlighting their distinct characteristics.

Estate Tax

Estate tax is a levy on a deceased person’s right to transfer property at death. It is primarily a federal tax in the United States, though some states also impose it. The estate itself pays this tax before assets are distributed to heirs, reducing the overall amount available for distribution.

The calculation of federal estate tax begins with determining the “gross estate,” which includes the fair market value of all assets the decedent owned at death. These assets can include cash, securities, real estate, life insurance proceeds, and business interests. Various deductions are allowed from the gross estate to arrive at the “taxable estate,” such as mortgages, debts, administration expenses, and property passing to a surviving spouse or qualified charities.

The unified credit allows a certain amount of an estate to pass tax-free. For 2025, the federal estate and gift tax exemption amount, also known as the basic exclusion amount, is $13.99 million per individual. The tax only applies to the portion of the taxable estate that exceeds this exemption.

For married couples, this exemption is effectively doubled, allowing up to $27.98 million to be transferred without federal estate tax. The highest federal estate tax rate is 40%, applied to the taxable portion exceeding the exemption. Without legislative action, this federal exemption amount is scheduled to revert to approximately $6 million to $7 million adjusted for inflation, starting January 1, 2026.

Inheritance Tax

Inheritance tax, unlike estate tax, is a tax on a beneficiary’s right to receive property from a deceased person. This tax is exclusively levied at the state level in the United States, with only a few states imposing it. The responsibility for paying the inheritance tax typically falls directly on the beneficiary or heir who receives the inherited assets.

The amount of inheritance tax owed often depends on the beneficiary’s relationship to the decedent. Many states provide exemptions or lower tax rates for close relatives, such as spouses, children, or direct descendants. Spouses are often fully exempt, and direct descendants may face minimal or no tax. More distant relatives or unrelated beneficiaries typically face higher tax rates.

Thresholds and exemptions also determine inheritance tax liability. A beneficiary might receive a certain amount of inherited assets tax-free, with the tax applying only to the value exceeding that threshold. These thresholds can vary based on the beneficiary’s relationship to the deceased. The tax is calculated on the value of specific assets inherited by each beneficiary, after considering applicable exemptions or deductions.

Inheritance tax rates vary significantly by state and beneficiary class, ranging from single-digit percentages to upwards of 15% or more for non-exempt beneficiaries. Beneficiaries should understand the specific rules of the state where the decedent resided or where the inherited property is located.

Key Distinctions

The primary difference between estate tax and inheritance tax lies in who pays the tax and what is taxed. Estate tax is levied on the deceased person’s estate for the privilege of transferring wealth at death. The estate pays this tax, reducing the total value available for inheritance.

Conversely, an inheritance tax is imposed on the individual beneficiary for the privilege of receiving an inheritance. The beneficiary pays this tax from the assets they receive. While an estate tax diminishes the overall estate, an inheritance tax reduces the portion each individual beneficiary receives.

Regarding taxing authority, estate tax is primarily federal, though some states also impose it. Inheritance tax is exclusively state-level, with only a limited number of states implementing it. This geographic distinction means residency and asset location can determine whether one or both taxes apply.

Exemptions and thresholds also differ. Federal estate tax applies a substantial exemption to the entire estate’s value, with tax only on amounts exceeding it. The unified credit combines lifetime gifts and transfers at death under one exemption. For inheritance tax, exemptions and rates are often determined by the beneficiary’s relationship to the decedent, with closer relatives typically receiving more favorable treatment.

Planning Considerations

Understanding estate and inheritance taxes is a step in comprehensive financial planning. Individuals should consider the potential applicability of these taxes based on their residency, asset location, and estate size. Awareness of federal and state thresholds helps anticipate future tax liabilities.

Establishing estate documents, such as a will, helps ensure assets are distributed according to one’s wishes and can streamline the probate process. While not directly avoiding these taxes, proper documentation helps manage estate administration efficiently. Strategic gifting during one’s lifetime can also be a consideration for wealth transfer.

Gifting assets within annual and lifetime exclusion limits can reduce a taxable estate. For 2025, individuals can gift up to $19,000 per recipient annually without impacting their lifetime exemption. Gifts exceeding this annual exclusion reduce the overall lifetime exemption available for estate tax purposes. Given potential changes to federal estate tax exemptions, reviewing one’s estate plan periodically is prudent. Seeking guidance from qualified financial and legal professionals is recommended to develop a personalized strategy.