Understanding Inheritance Tax and Who Pays It

What Is Inheritance Tax and How Does It Work?

Inheritance tax, often called estate tax or death tax, is a tax that applies to money and property passed from a person who has died to their heirs or beneficiaries. When someone passes away, the total value of everything they owned—their estate—may be subject to taxation before it gets distributed to the people who inherit it. Understanding how this tax works helps families plan for what happens to their assets after death.

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The process begins when a person dies and leaves behind assets such as a home, bank accounts, investments, vehicles, jewelry, or a business. An executor or administrator of the estate gathers all these items, determines their total value, and follows legal requirements for distributing them. If the estate's value exceeds a certain threshold set by law, taxes must be paid on the amount above that threshold. These taxes reduce the amount of money and property the heirs actually receive.

Inheritance tax differs from income tax or property tax because it specifically targets the transfer of wealth from one generation to the next. The tax is calculated based on the total value of the entire estate, not on individual items within it. Federal inheritance tax rates vary depending on when someone dies, because Congress periodically changes tax laws. As of 2024, the federal threshold is quite high—over $13 million per person—meaning most estates do not owe federal inheritance tax. However, some states have their own inheritance or estate taxes with much lower thresholds.

The timing of when taxes are paid matters. Typically, estate taxes must be paid within nine months of a person's death, though extensions are sometimes possible. If the taxes are not paid on time, penalties and interest charges can accumulate. The money to pay these taxes usually comes from the estate itself, which means there is less money left for the people who inherit.

Practical Takeaway: Inheritance tax affects only estates above certain value thresholds, and the rates vary by state and federal law. Before assuming an estate owes taxes, the total value of all the deceased person's assets must be calculated to determine whether the threshold has been crossed.

Federal Inheritance Tax Thresholds and Who Actually Pays

Not everyone who inherits money pays inheritance tax. The federal government only applies inheritance tax to estates that exceed a certain value, called the exemption threshold or exclusion amount. In 2024, this threshold is $13.61 million per person. This means if a person dies and leaves behind assets worth $13 million, no federal inheritance tax is owed. Only the portion of the estate above this amount gets taxed.

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This threshold is not permanent. Congress has changed it many times throughout history, and it is scheduled to change again. In 2025 and beyond, the threshold is set to drop to approximately $7 million per person (adjusted for inflation) unless Congress passes new legislation. This means fewer estates will fall below the threshold, and more families could potentially owe federal inheritance taxes in the future. It is important to monitor changes to tax law because they directly affect how much of an estate gets passed to heirs.

For married couples, the situation is different. A surviving spouse can use both their own exemption and their deceased spouse's unused exemption, essentially doubling the threshold. This is called "portability" of the exemption. A married couple with a combined estate worth $27 million (or close to it) might not owe any federal inheritance tax if they structure their estate properly and the surviving spouse survives the deceased spouse. However, to claim this benefit, the estate must file a federal estate tax return even if no tax is owed, and specific elections must be made within the required timeframe.

States have their own rules about inheritance taxes, and these rules vary widely. Some states have no inheritance or estate tax at all. Others have thresholds as low as $1 million or less. In some states, heirs themselves pay the tax, while in others, the estate pays it. For example, Iowa and Kentucky impose an inheritance tax where the burden falls partly on the people receiving money, with rates varying based on their relationship to the deceased and the amount inherited. The six states that currently have an estate tax (Connecticut, Illinois, Maine, Massachusetts, Minnesota, and Oregon) apply taxes similar to the federal system, where the estate pays the tax before distribution.

Practical Takeaway: The majority of estates do not owe federal inheritance tax because the threshold is high. However, state taxes may apply at much lower thresholds, so checking your state's specific laws is crucial. For married couples, the exemption can potentially double, but proper planning and documentation are necessary.

Types of Assets Included in a Taxable Estate

An estate includes almost everything a person owned at the time of death. This is broader than many people realize. The primary assets are obvious: real estate (houses, land, rental properties), bank accounts, investment accounts (stocks, bonds, mutual funds), and retirement accounts (401k plans, IRAs). However, many other items count toward the total estate value and factor into whether inheritance tax is owed.

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Life insurance policies are often included in an estate's value, even though the money from them goes directly to named beneficiaries. This surprises many people, but the death benefit is counted as part of the estate if the deceased person owned the policy. If someone purchases a life insurance policy on themselves, the death benefit is generally included in their estate. However, if a spouse, adult child, or trust owns the policy, the proceeds may not be included. The difference can affect whether an estate crosses the tax threshold.

Retirement accounts like traditional IRAs, Roth IRAs, and 401k plans are included in estates. When a person with a $2 million IRA passes away, that $2 million counts toward the total estate value. The same applies to annuities, which are insurance products that pay out money over time or in a lump sum. Jointly owned property also counts. If two people own a house together with joint survivorship rights, the deceased person's share is included in their estate's value.

Smaller items that people sometimes forget to count include vehicles, jewelry, collectibles (art, antiques, coins), business interests, and intellectual property. A person who owned a successful small business would have that business's value added to their estate. Royalties from books, patents, or music also count. Even items with sentimental rather than monetary value—such as family heirlooms—must be appraised and included if they have resale value. Debts and liabilities, such as mortgages or loans, are subtracted from the total before calculating taxes, which can significantly reduce the taxable estate.

There are certain items and transfers that are not included in a taxable estate. Money given away during a person's lifetime under the annual gift tax exclusion (currently $18,000 per recipient per year in 2024) generally does not count. Charitable donations made during life or at death are also excluded. Medical and tuition payments made directly to providers on behalf of others are not counted as gifts. These exclusions can be valuable planning tools for people with large estates.

Practical Takeaway: An estate includes far more than just a house and bank accounts. Life insurance, retirement accounts, jointly owned property, and business interests all count toward the total value that determines whether inheritance tax is owed. Understanding what counts helps in planning a more tax-efficient transfer of wealth.

How Inheritance Tax Rates Are Calculated

The federal inheritance tax rate structure is progressive, meaning higher estate values are taxed at higher rates, similar to income tax. However, the rates are steep—starting at 18 percent on the smallest taxable amounts and reaching 40 percent on the largest portions. This means that for every dollar of an estate that exceeds the exemption threshold, a significant portion goes to taxes rather than to heirs.

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Here is how the calculation works in practice. Suppose someone dies in 2024 with an estate worth $15 million. The first $13.61 million is exempt from tax. This leaves $1.39 million that is subject to taxation. This $1.39 million does not all get taxed at the 40 percent rate. Instead, the tax is calculated using brackets. The lowest amounts are taxed at lower rates, and the amount increases as larger portions are taxed at higher rates. On $1.39 million over the exemption, the federal inheritance tax would be approximately $556,000. This example shows how the high threshold protects most estates, but those that exceed it can face substantial taxes.

State inheritance taxes are calculated differently depending on the state. Some states use a similar progressive rate structure as the federal government