What Is the Difference Between Inheritance Tax and Estate Tax?
Demystify the crucial differences between inheritance tax and estate tax. Gain clarity on how these taxes on transferred wealth truly function.
Taxes on inherited assets can be confusing. The terms “estate tax” and “inheritance tax” sound similar, yet they apply distinctly to different aspects of wealth transfer after death. Understanding their fundamental differences is important for financial planning and managing inherited assets.
What is Estate Tax
Estate tax is a tax levied on a deceased person’s right to transfer property at their death. This tax applies to the total value of the individual’s assets, known as their “gross estate,” before any distribution to heirs. The estate itself is responsible for paying this tax, not the individual beneficiaries who receive the assets.
The gross estate encompasses a wide range of assets owned by the decedent at the time of death. This includes real estate, cash, stocks, bonds, and business interests. It also extends to certain life insurance proceeds, retirement accounts, and specific types of property transferred during the decedent’s lifetime. The fair market value of these assets is used to calculate the gross estate.
A federal estate tax exists, which applies uniformly across the United States for estates exceeding a certain value. In addition to the federal tax, some individual states also impose their own estate taxes. These state-level estate taxes operate independently of the federal system, often with their own specific rules and exemption thresholds.
What is Inheritance Tax
Inheritance tax is a tax imposed on an individual’s right to receive property from a deceased person. Unlike the estate tax, the burden of paying the inheritance tax falls directly on the individual beneficiary who inherits the assets. The tax rate applied often depends on the familial relationship between the beneficiary and the deceased.
Beneficiaries closely related to the deceased, such as spouses and direct descendants, face lower tax rates or are exempt from this tax. More distant relatives or non-relatives incur higher inheritance tax rates. This tax is exclusively levied at the state level; there is no federal inheritance tax.
The specific rules regarding exemptions and rates vary considerably among states that impose inheritance tax. These taxes are calculated based on the value of the portion of the estate that each beneficiary receives.
Who Pays and How They Differ
The primary distinction between estate tax and inheritance tax lies in who is responsible for paying the tax. Estate tax is paid by the deceased person’s estate itself, reducing the total value of assets available for distribution to heirs. Conversely, inheritance tax is paid by the individual beneficiaries after they receive their portion of the inheritance.
The taxable event also differs fundamentally. Estate tax is assessed on the transfer of the deceased’s entire estate as a single entity, considering its total value before any division. Inheritance tax is triggered by the receipt of individual shares of the estate by each beneficiary.
Estate tax calculations are based on the fair market value of the deceased’s total estate. In contrast, inheritance tax is determined by the value of the specific portion of the estate received by each beneficiary. The relationship between the beneficiary and the deceased significantly influences inheritance tax rates and potential exemptions, a factor that does not directly impact federal estate tax.
Federal and State Considerations
The federal estate tax applies to a decedent’s gross estate that exceeds a substantial exemption amount. For 2025, the federal estate tax exemption is $13.99 million for individuals, meaning only a small percentage of very large estates are subject to this tax. This exemption is scheduled to increase to $15 million per individual in 2026.
Several states impose their own estate taxes. These include Connecticut, Hawaii, Illinois, Maine, Maryland, Massachusetts, Minnesota, New York, Oregon, Rhode Island, Vermont, Washington, and the District of Columbia. Their exemption thresholds vary widely, with some being considerably lower than the federal exemption.
Only a handful of states levy inheritance tax. These states are Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. Maryland is unique in that it levies both an estate tax and an inheritance tax. Rates and beneficiary exemptions for these taxes differ significantly depending on the state’s statutes.