Understanding the Key Differences in Estate Tax vs. Inheritance Tax
They say there are only two things you can't avoid: death and taxes. But did you know there's a kind of tax that kicks in after someone has passed away? These are often called "death taxes," and they can get complicated fast, especially since the rules change depending on where you live.
However, understanding the basic difference between the two main types is the best place to start. This distinction is vital for good estate planning, no matter the size of the assets involved.
The Estate Tax: A Tax on the Deceased's Assets
The estate tax is basically a tax on the value of the deceased person's entire estate. Think of it as a final tax bill for everything that person owned.
The key thing to remember is that this tax is paid by the estate itself, and the money is paid before any assets or funds are handed out to the people who inherit them (the beneficiaries).
Federal Estate Tax
The U.S. federal government does charge an estate tax, but it has a very high exemption rate. As of 2025, if the estate is worth less than $13.99 million, the federal government won't charge any estate taxes on it. Because this limit is so high, most estates don't have to worry about the federal estate tax. These rates have generally only increased, but future rates will depend on legislation.
State Estate Taxes
Here's where it can get complicated. A number of states have their own estate taxes, and their exemption rates can be much lower than the federal limit. This means an estate that easily avoids the federal tax might still be on the hook for a state estate tax.
The Inheritance Tax: A Tax on the Beneficiary's Gift
The inheritance tax works completely differently. Instead of taxing the deceased’s estate, it's a tax charged on the value of the assets received by the individual beneficiary.
The key takeaway here is that this tax is paid directly by the people who inherit the money or assets, not by the estate.
The Federal Stance on Inheritance Tax
The good news is, the federal government doesn't charge an inheritance tax at all. The reason for this is that the federal tax system uses the estate tax—that is, taxing the total value of the wealth before it's given away. The government focuses its effort on that one big account rather than having to track and tax every single person who inherits something different. That job is generally left up to the states—if they choose to do it.
State Inheritance Taxes
Just like with the state estate tax, only a handful of states charge an inheritance tax. The actual tax rates generally depend on the relationship between the person inheriting the money and the person who passed away. Close relatives like spouses or children are often exempt, but distant relatives or unrelated beneficiaries may have to pay a higher tax rate on what they receive.
What Happens in Real Life: When Both Taxes Apply
Understanding the tax consequences of inheritance means knowing when these two taxes might cross paths based on where the person lived.
The Double Tax Scenario
In places that have both a state estate tax and a state inheritance tax, like Maryland, you could face a double hit. The estate pays the state estate tax first, and then the individual heir may have to pay the state inheritance tax on the portion they receive.
Where You Lived Matters Most
The most important thing for state taxes is the deceased person's official legal residence, or domicile. The laws of that state decide which state taxes (if any) are applied. Keep in mind, though, that if the person owned property in another state, that state’s laws may also apply.
Tax-Free Family Members
Remember, even in the states that have an inheritance tax, certain close relatives (like a surviving spouse) are often called tax-free beneficiaries. This exemption helps make sure that the main assets going to the closest family aren't overly taxed.
What You Can Do Now to Prepare for the Future
Dealing with these complicated topics is hard, especially when you're grieving. Being prepared and planning ahead can save your loved ones a lot of stress later.
Get Your Own Estate in Order
The most important step is setting up a clear estate plan. This plan—which includes a will and other documents—should be created by every adult over 18, no matter how much money they have right now. A good plan makes the legal and financial process much simpler for the people who will handle your affairs later.
Seek Professional Guidance
Because state and federal tax codes are always changing, getting professional help is key. Whether you're planning your own estate or dealing with the affairs of a loved one, you should talk to a trustworthy financial advisor or an estate attorney. They can help you navigate the constantly changing tax codes and make sure everything is done legally and efficiently during a difficult time.
Clarity Provides Comfort
While taxes after death are complicated, taking proactive steps now to understand the difference between estate and inheritance tax will help protect your legacy—and give your loved ones a clearer path when they need it most.
