How Is Inheritance Tax Different From Estate Tax?
The estate tax is paid by the estate based on the total value of the deceased's assets — it reduces the estate before distribution. Inheritance tax is paid by each beneficiary based on what they receive. A single estate could generate multiple inheritance tax bills at different rates. Maryland is the only state that imposes both an estate tax and an inheritance tax, though credits prevent true double taxation on the same assets.
How Are Inheritance Tax Rates Determined?
Inheritance tax rates depend primarily on the relationship between the beneficiary and the deceased. Surviving spouses are exempt in all six states. Direct descendants (children, grandchildren) are exempt or pay very low rates in most states. Siblings typically face moderate rates (5-15%). Unrelated beneficiaries face the highest rates — up to 15-18% in some states. Each state sets its own exemption thresholds and rate schedules, making it essential to understand your specific state's rules.
How Can You Minimize Inheritance Tax?
Strategies to reduce inheritance tax include: lifetime gifting to reduce the taxable estate (staying within annual gift tax exclusion limits); using irrevocable trusts to remove assets from the estate; purchasing life insurance in an irrevocable life insurance trust (ILIT) to provide tax-free funds; converting assets to forms that pass outside the inheritance tax (like jointly held property); and considering state residency — only six states have inheritance tax, and moving to a state without one eliminates the liability.
Frequently asked questions
Do all states have an inheritance tax?
No. Only six states currently impose inheritance tax: Iowa (phasing out by 2025), Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. The vast majority of Americans never pay inheritance tax. Check your state's specific laws, as rules change periodically.
Is inherited money considered income?
Generally, no. Inherited assets are not considered taxable income under federal tax law. However, income generated by inherited assets (interest, dividends, rent) is taxable. Inherited retirement accounts require distributions that are taxed as ordinary income. The inheritance itself is not subject to federal income tax.