Inheritance Tax vs Estate Tax: Key Differences
Many people use "estate tax" and "inheritance tax" interchangeably — but they're legally distinct taxes with different payers, different rates, and different planning implications. Understanding the difference matters enormously for families doing serious estate planning.
Estate Tax vs. Inheritance Tax: The Key Distinction
Estate tax is levied on the estate itself — calculated against the total value of assets owned by the deceased before distribution to heirs. The executor pays estate tax out of the estate's assets before beneficiaries receive anything.
Inheritance tax is levied on the heirs — calculated against the amount each individual heir receives. The beneficiary is responsible for paying the tax, though estates sometimes pay it on behalf of heirs depending on the will.
In practice, both reduce the amount heirs ultimately receive. But the payer, the return, and the planning strategies differ.
Federal Estate Tax
The federal estate tax applies to estates exceeding the federal exemption amount. For 2026, the exemption is approximately $13.99 million per individual.
Married couples can effectively double this to $27.98 million through portability — the surviving spouse can elect to use the deceased spouse's unused exemption, provided a timely estate tax return (Form 706) is filed.
Tax rate: A flat 40% applies to the taxable estate above the exemption.
Example: An estate worth $16 million (individual, no trusts) faces estate tax on $16M – $13.99M = $2.01M × 40% = $804,000 in federal estate tax.
There is no federal inheritance tax. Amounts received by heirs from an estate are not generally subject to federal income tax (with some exceptions for inherited IRAs and retirement accounts, which have their own tax rules).
State Estate Taxes
Beyond the federal tax, 12 states plus Washington DC impose their own estate taxes — often with much lower exemptions:
| State | Exemption | Top Rate |
|---|---|---|
| Massachusetts | $2 million | 16% |
| Oregon | $1 million | 16% |
| Minnesota | $3 million | 16% |
| Illinois | $4 million | 16% |
| Washington | $2.193 million | Up to 20% |
| New York | $7.16 million | 16% |
| Connecticut | $13.99 million (matches federal) | 12% |
| Maine | $6.8 million | 12% |
| Maryland | $5 million | 16% |
| Vermont | $5 million | 16% |
| Hawaii | $5.49 million | 20% |
| Rhode Island | $1.77 million | 16% |
New York's cliff rule is especially harsh: if an estate exceeds 105% of the $7.16M exemption, the entire exemption is eliminated and the full estate is taxed. An estate of $7.51M could owe more estate tax than an estate of $7.16M.
State domicile planning — establishing primary residence in a state with no estate tax (like Florida, Texas, or Nevada) before death — is a critical strategy for estates in the $5M–$15M range.
Inheritance Tax: The 6 States
Only six states currently impose an inheritance tax:
| State | Who Pays | Surviving Spouses? | Children? |
|---|---|---|---|
| Iowa | Heirs | Exempt | Exempt |
| Kentucky | Heirs | Exempt | Exempt |
| Maryland | Heirs | Exempt | Exempt |
| Nebraska | Heirs | Exempt | Partial exemption |
| New Jersey | Heirs | Exempt | Exempt |
| Pennsylvania | Heirs | Exempt | 4.5% rate |
Key patterns:
- Surviving spouses are universally exempt from inheritance tax in all six states
- Children and direct descendants are typically exempt or taxed at low rates
- More distant relatives and non-relatives (friends, partners, stepchildren in some states) face the highest rates — sometimes 10–18%
- Maryland is the only state with both an estate tax and an inheritance tax
The practical impact of inheritance tax falls hardest on assets left to non-immediate family: siblings, nieces, nephews, unmarried partners, and friends. A large bequest to a close friend in Pennsylvania could trigger a 15% inheritance tax on the full amount received.
Step-Up in Basis: The Critical Planning Concept
At death, inherited assets receive a step-up in basis to their fair market value on the date of death (or the alternate valuation date, if elected). This eliminates all accrued capital gains built up during the decedent's lifetime.
Example: You purchased stock for $10,000 that grew to $500,000 by the time of death. Your heir inherits at a $500,000 basis — if they sell immediately, they owe zero capital gains tax on that $490,000 of gain. If you had sold during life, you'd have owed potentially $98,000+ in federal capital gains tax (20% rate) plus 3.8% NIIT.
Step-up in basis makes it often advantageous to hold highly appreciated assets until death rather than selling them or gifting them during life (gifts carry over your original basis, not a stepped-up basis).
Note: Assets held in IRAs and retirement accounts do not receive a step-up in basis — they are "income in respect of a decedent" and taxed as ordinary income when inherited beneficiaries take distributions.
Portability: Preserving the Unused Exemption
When the first spouse of a married couple dies, their unused estate tax exemption doesn't automatically transfer. To preserve it, the surviving spouse must elect portability by filing a federal estate tax return (Form 706) within nine months of death (with extensions available).
Even if no estate tax is owed, filing Form 706 to elect portability can save millions for wealthy couples. Without portability, the second spouse's estate can only use a single exemption of $13.99M — with it, they may use both, potentially shielding $27.98M from federal estate tax.
Estate Planning Strategies
Annual Gift Tax Exclusion
The annual exclusion allows gifts of up to $18,000 per recipient per year (2025–2026) without using any lifetime exemption or triggering gift tax. Married couples can combine this to $36,000 per recipient. Over time, systematic gifting removes substantial amounts from the taxable estate: $18,000 × 5 children × 10 years = $900,000 out of the estate, tax-free.
Direct Tuition and Medical Payments
Unlimited amounts paid directly to educational institutions (tuition only, not room and board) or directly to medical providers are excluded from gift tax entirely. These payments don't count against the annual exclusion or lifetime exemption — a powerful wealth transfer tool for grandparents.
Irrevocable Trusts
Assets moved into an irrevocable trust generally leave the taxable estate (if structured correctly). Common trusts in estate planning include SLATs (Spousal Lifetime Access Trusts), ILITs (Irrevocable Life Insurance Trusts), and GRATs (Grantor Retained Annuity Trusts).
Charitable Strategies
Charitable bequests reduce the taxable estate dollar-for-dollar. Charitable Remainder Trusts (CRTs) and donor-advised funds provide income tax benefits during life while reducing estate size.
To estimate your potential estate tax liability, use our Estate Tax Calculator.
This article is for informational purposes only. Estate and inheritance tax rules are highly state-specific and subject to change. Always work with a qualified estate planning attorney and tax professional for planning that involves significant assets.