Did you know that the Tax Policy Center reports that in 2023, only about 4,000 estate tax returns were taxable, affecting less than 0.2% of the 2.8 million people who passed away? That’s because estate tax and inheritance tax don’t apply to everyone—but when they do, they can significantly impact family wealth. If you're planning your estate or expecting an inheritance, understanding these taxes is indispensable. In this article, explore estate and inheritance taxes, their differences, and how you can prepare for 2025 tax obligations.
What Is Estate Tax?
Estate tax is a federal and state tax levied on the total value of a deceased person’s estate before it is transferred to beneficiaries. Often called the "death tax," it applies only to estates exceeding the federal estate tax threshold. For 2025, the federal estate tax exemption is $13.99 million, meaning only estates above this amount are subject to federal estate tax. However, 12 states and the District of Columbia impose their own state estate tax, with exemption amounts as low as $1 million.
If you’re an executor, you are responsible for filing IRS Form 706 to report the gross estate and calculate any estate taxes owed. The estate pays the tax before distributing assets to heirs. A surviving spouse is exempt from paying estate tax due to the marital deduction, meaning they can inherit everything tax-free. However, when assets pass to non-spouse heirs, federal and state estate taxes may apply.
How Is Estate Tax Calculated?
The taxable estate is calculated based on the fair market value of all assets owned at the time of death, minus certain deductions. Here’s what’s included:
Assets That Make Up the Gross Estate
- Real estate – Primary residence, vacation homes, rental properties
- Cash and bank accounts – Checking, savings, CDs
- Investments – Stocks, bonds, mutual funds, retirement accounts
- Business interests – Ownership in private businesses, partnerships
- Life insurance – If owned by the deceased, the death benefit is included in the gross estate
- Money or property – Vehicles, collectibles, jewelry, intellectual property
Deductions That Reduce the Taxable Estate
Before the federal estate tax rates apply, several deductions lower the estate’s value:
- Debts & liabilities – Mortgages, credit card balances, personal loans
- Funeral expenses – Burial, cremation, memorial services
- Charitable contributions – Gifts to qualified nonprofits are tax-free
- Marital deduction – A surviving spouse can inherit all assets exempt from paying estate tax
- State taxes – Some states allow additional deductions before calculating their state estate tax
After deductions, the remaining amount is the net taxable estate, which is subject to federal and state estate taxes if it exceeds the estate tax exemption amount.
Further Reading: Learn the basics of inheritance tax and estate
What Are the Federal Estate Tax Rates for 2025?
For 2025, the IRS estate tax threshold is $13.99 million per individual, meaning any estate valued below this is exempt from federal estate tax. If an estate exceeds this limit, it is taxed at rates that range from 18% to 40%.
Federal estate tax rates (2025):
- 18% on taxable estates up to $10,000
- 40% on taxable estates exceeding $1 million over the exemption amount
State Estate Taxes – 12 States and the District of Columbia
While federal estate tax applies only to very large estates, 12 states and Washington, D.C. impose a state estate tax, and their exemption amounts vary by state. Some states have a much lower threshold, meaning more estates are subject to state estate tax even if they are exempt from federal estate tax.
If your estate is near the federal or state estate tax threshold, consulting a tax advisor or estate planning attorney can help ensure you minimize the tax burden on your heirs.
Further Reading: Learn how federal tax extensions work and how they apply to your state taxes
What Is Inheritance Tax?
Unlike estate tax, which is paid by the estate, inheritance tax is paid by the beneficiary who receives the assets. This means that if you inherit money or property from someone who lived in a state with an inheritance tax, you may owe taxes based on your relationship to the deceased.
Which States Have an Inheritance Tax?
Currently, six states impose an inheritance tax:
- Iowa (phasing out by 2025)
- Kentucky
- Maryland
- Nebraska
- New Jersey
- Pennsylvania
Even if you don’t live in these states, you might still owe inheritance tax if the deceased lived in a state with an inheritance tax.
Who Has to Pay Inheritance Tax?
Whether you owe inheritance tax depends on:
1. Your Relationship to the Deceased
- Spouses – Always exempt from paying inheritance tax
- Children & grandchildren – Often taxed at a lower rate or exempt in some states
- Siblings, nieces, nephews – Typically subject to inheritance tax
- Distant relatives & non-family members – Pay the highest tax rate
2. The State’s Tax Rate
Each state government sets its own inheritance tax rates, which range from 1% to 18%. The further your relationship from the deceased, the higher the tax rate you’ll pay.
If you’re inheriting significant wealth, consulting a tax professional or estate planning attorney can help ensure you understand your tax obligations and explore ways to minimize them.
Further Reading: Discover answers to common questions about estate taxes
Estate Tax vs. Inheritance Tax: Key Differences
Who Pays the Tax?
- Estate tax – Paid by the estate before heirs receive their inheritance
- Inheritance tax – Paid by the beneficiary after receiving assets
Federal vs. State Taxation
- Estate tax – Federal and state level
- Inheritance tax – Only at the state level in six states
Estate Planning: How to Minimize Tax Obligations
Proper estate planning can help reduce your tax burden and ensure your heirs receive as much of your wealth as possible.
Using Trusts to Reduce Estate Taxes
Setting up a trust can protect your estate from excessive taxation.
- Irrevocable Life Insurance Trust (ILIT) – Keeps life insurance proceeds out of your taxable estate, reducing federal and state estate taxes.
- Grantor Retained Annuity Trust (GRAT) – Allows you to transfer appreciating assets to beneficiaries while minimizing estate tax exposure.
Gifting Strategies to Reduce Taxable Estate
You can legally reduce your gross estate by giving away assets during your lifetime:
- Annual Gift Tax Exclusion – In 2025, you can gift up to $18,000 per recipient tax-free, reducing your taxable estate.
- Lifetime Gift Tax Exemption – Any gifts exceeding the annual exclusion count toward your $13.99 million exemption.
- Direct Payments for Education & Medical Expenses – Payments made directly to schools or medical providers are exempt from gift tax.
Using these strategies, you can lower your estate tax liability and protect your wealth for future generations. Working with an estate planning attorney or financial professional ensures you make the most of available tax exemptions while keeping your estate compliant with IRS and state laws.
Key Takeaways
- Estate tax is paid by the estate before assets are distributed, while inheritance tax is paid by the beneficiary.
- For 2025, the federal estate tax exemption is $13.99 million, with tax rates ranging from 18% to 40%.
- Only six states impose an inheritance tax, and tax rates vary based on the beneficiary’s relationship to the deceased.
- Twelve states and Washington, D.C. have a state estate tax, with lower exemption amounts than the federal threshold.
- Estate planning strategies like trusts and gifting can help minimize tax burdens and protect wealth for heirs.
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