Did you know the U.S. government once used inheritance tax to help fund wars? According to the Tax Foundation, inheritance tax was temporarily introduced during the Civil War and the Spanish-American War. Today, inheritance taxes only exist at the state level, leaving many heirs confused about their tax responsibilities.
If you're inheriting assets in 2025, understanding inheritance tax is crucial to avoid unexpected tax bills. This article details everything you need to know—what it is, which states have it, and how you can minimize its impact.
What Is Inheritance Tax and How Does It Work?
Inheritance tax is a state tax imposed on beneficiaries who receive an inheritance from a deceased person. Unlike estate taxes, which are paid by the estate of the deceased before distribution, inheritance tax is paid by the heir. The amount owed depends on the inheritance tax rate, the value of the assets, and the relationship to the deceased.
Understanding Inheritance Tax
Inheritance tax is a tax on inheritances that applies only in certain states. The tax rate is 10% or higher in some cases, depending on the state where the decedent lived or owned property.
Key Factors That Determine Inheritance Tax
- State laws: Only six states impose an inheritance tax (Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania).
- Size of the estate: The fair market value of inherited assets affects the tax rate ranges that apply.
- Relationship to the deceased: Spouses are exempt from inheritance tax, while non-relatives may face higher tax rates.
- Exemptions and tax thresholds: Some states offer estate tax exemptions or reduced rates for close family members.
Inheritance Tax vs. Estate Tax: What’s the Difference?
Inheritance tax and estate tax are often confused, but they are not the same.
Some estates may be subject to both federal estate tax and state inheritance tax, depending on their size and location.
Further Reading: Uncover the differences between estate tax and inheritance tax
Who Needs to Pay Inheritance Tax?
Which States Impose an Inheritance Tax?
Currently, six states levy inheritance tax:
Who Is Exempt from Inheritance Tax?
- Spouses are always exempt from inheritance tax in all states.
- Children and grandchildren may receive exemptions or reduced tax rates.
- Charities are usually exempt.
Who Pays the Highest Inheritance Tax Rates?
- Non-relatives and business partners typically face higher tax rates.
- Distant relatives (e.g., cousins, nieces, nephews) may be subject to inheritance tax depending on the state.
Further Reading: Learn the basics of inheritance tax and estate tax
How Inheritance Tax Affects Beneficiaries in 2025
Do You Pay Taxes on an Inherited Estate?
- If you live in a state that doesn’t impose inheritance tax, you won’t owe anything—even if the deceased person lived in a taxed state.
- However, real estate is taxed based on the state where the decedent owned property. If you inherit a house in Pennsylvania, you may be subject to inheritance tax—even if you live elsewhere.
How Much Tax Will You Owe?
The inheritance tax is assessed based on:
- The inheritance tax rate in the state.
- The value of the assets inherited.
- Your relationship to the deceased.
Example tax implications:
- If you inherit $100,000 from a non-relative in Nebraska, you could owe $15,000 (15% tax rate).
- If you inherit the same amount from a parent in New Jersey, you may owe nothing, since children are exempt from inheritance tax.
Strategies to Minimize or Avoid Inheritance Tax
Utilizing Estate Planning Tools
Planning ahead with estate planning strategies can reduce the tax burden:
- Gifting assets before death
- The annual gift tax exclusion for 2024 is $18,000 per recipient—this allows individuals to transfer wealth tax-free before death.
- Gifts above this amount may be subject to federal gift tax, but it can help lower estate tax applies limits.
- Establishing an irrevocable trust
- Assets placed in an irrevocable trust are not subject to inheritance tax in most cases.
- Types of trusts that help reduce tax liabilities:
- Grantor Retained Annuity Trust (GRAT)
- Qualified Personal Residence Trust (QPRT)
- Relocating to a state without inheritance tax
- Moving to Iowa in 2025 (when it fully phases out inheritance tax) or another tax-free state can eliminate tax burdens for heirs.
Are There Legal Ways to Avoid Paying Inheritance Tax?
Yes, these strategies can help reduce or eliminate inheritance tax:
- Charitable donations: Donating a portion of an inheritance to a tax-exempt charity lowers taxable assets.
- Life insurance policies: Payouts from life insurance policies are tax-free and not subject to inheritance tax.
- Joint ownership of property: Some states exempt jointly owned property from inheritance tax when a co-owner passes away.
Further Reading: Discover IRS rules for gifting money to family
Key Takeaways
- Inheritance tax is a state tax that applies in six states.
- Spouses and children are often exempt, while non-relatives may be subject to higher inheritance tax rates.
- Inheritance tax depends on state tax laws, the value of assets, and the heir’s relationship to the deceased.
- Estate planning strategies like irrevocable trusts, gifting, and relocation can minimize inheritance tax burdens.
- Consult a tax professional to understand how estate tax applies to estates and whether an inheritance is subject to federal estate tax.
How can Taxfyle help?
Finding an accountant to file taxes is a big decision. Luckily, you don't have to handle the search on your own.
At Taxfyle, we connect you with licensed, experienced CPAs or EAs in the US. We handle the hard part of finding the right tax professional by matching you with a Pro who has the right experience to meet your unique needs and will file your file taxes for you.
