What inheritance tax is and who pays it

Inheritance tax is a tax on money and property you receive from someone who has died. Not every state has it — only Maryland, New Jersey, Pennsylvania, Iowa, Kentucky, and Nebraska currently collect inheritance tax. The person who receives the inheritance pays the tax, not the estate itself. The tax rate and the amount you can receive tax-free depend on your relationship to the person who died and which state's law applies.

Federal estate tax is different. It applies only to estates worth more than a certain amount — $13.61 million in 2024, though this threshold changes yearly and is scheduled to drop in 2026. Most people never encounter federal estate tax because their estates fall below that threshold. State inheritance tax, by contrast, can explore to much smaller amounts and affects more people.

The relationship between you and the deceased matters most. Spouses are usually exempt from inheritance tax entirely. Children, parents, and grandparents often pay reduced rates or have higher exemptions. Unrelated people and distant relatives typically pay the highest rates.

Key Takeaways

  • Only six states have inheritance tax, and spouses are almost always exempt regardless of the amount received.
  • Giving money away during your lifetime can reduce what your heirs inherit and therefore what they owe in tax.
  • Placing assets in a trust can keep them out of your taxable estate, though the rules vary by state and asset type.
  • Life insurance proceeds are usually not subject to inheritance tax if the policy is owned correctly.
  • Retirement accounts and certain savings accounts pass directly to named beneficiaries and may avoid inheritance tax entirely.

Give money away while you are alive

The simplest way to reduce what your heirs inherit is to give money or property to them before you die. In 2024, you can give up to $18,000 per person per year without triggering any tax or reporting requirement. If you are married, you and your spouse can each give $18,000 to the same person, totaling $36,000 per year. This amount changes yearly with inflation.

You can also give larger amounts without when ready tax consequences by using your lifetime gift tax exemption, which is $13.61 million in 2024. However, using your lifetime exemption reduces the amount your estate can pass tax-free to your heirs after you die. For most people, the annual $18,000 gift limit is the practical route because it does not touch your lifetime exemption.

Gifts to spouses and to charities have no limit and do not count against your exemption. Paying someone's tuition or medical bills directly to the provider also does not count as a taxable gift, even if the amount exceeds $18,000.

Use a revocable living trust to hold your assets

A revocable living trust is a legal document that lets you transfer ownership of your assets to a trust while you are alive. You remain in control of the trust and can change it or take assets out at any time. When you die, the assets in the trust pass directly to your named beneficiaries without going through probate.

The main inheritance tax benefit is that assets in a revocable trust are not subject to probate in the state where you died, which can reduce state-level taxes and fees. However, the trust itself does not reduce your federal estate tax or state inheritance tax — the assets are still counted as part of your taxable estate. The real value of a revocable trust is avoiding probate costs and delays, not tax reduction.

An irrevocable trust works differently. Once you put assets into an irrevocable trust, you cannot take them back or change the terms. Because you no longer own the assets, they are not part of your taxable estate. This can reduce both federal estate tax and state inheritance tax. The tradeoff is that you lose control of the assets and cannot change your mind. Irrevocable trusts are more complex and usually require a lawyer to set up.

Name beneficiaries on retirement accounts and bank accounts

Money in retirement accounts like 401(k)s and IRAs passes directly to whoever you name as beneficiary, bypassing your will and your estate. The same is true for life insurance policies, payable-on-death bank accounts, and transfer-on-death investment accounts. These assets do not go through probate and are usually not subject to state inheritance tax.

The key is to name a beneficiary and keep that designation current. If you do not name anyone, the account becomes part of your estate and is subject to inheritance tax. If you name your estate as beneficiary, the same problem occurs. Review your beneficiary designations every few years, especially after a major life event like marriage, divorce, or the birth of a child.

Some states treat inherited retirement accounts differently depending on whether the beneficiary is a spouse, a child, or someone else. A spouse can usually roll an inherited IRA into their own account. Non-spouse beneficiaries have more limited options. Check your state's rules or ask your account provider what happens to the account after you die.

Buy life insurance owned by someone else or a trust

Life insurance proceeds are normally not subject to income tax, but they are included in your taxable estate if you own the policy. This can push your estate over the federal threshold and trigger estate tax. The solution is to have someone else own the policy or to place it in an irrevocable trust.

If your adult child or spouse owns the policy on your life, the proceeds go to them tax-free and are not part of your estate. You can still pay the premiums — the IRS allows you to give money to the policy owner as a gift, up to the annual limit. This strategy works best if you have a large estate and expect to owe federal estate tax.

An irrevocable life insurance trust (ILIT) is a trust that owns the policy. When you die, the proceeds go into the trust and are distributed according to the trust terms. The proceeds are not part of your taxable estate. Setting up an ILIT requires a lawyer and is most useful for people with estates over $5 million.

Leave money to your spouse or to charity

Anything you leave to your spouse is exempt from both federal estate tax and state inheritance tax in all states. This is called the marital deduction. You can leave your entire estate to your spouse with no tax consequence. The tax is deferred until your spouse dies and leaves money to your children or others.

Charitable donations are also exempt from estate tax and inheritance tax. If you leave money or property to a may have access to charity, that amount does not count toward your taxable estate. You can combine this with other strategies — for example, leaving part of your estate to charity and the rest to your children in a way that reduces the tax your children owe.

A charitable remainder trust lets you receive income from an asset during your lifetime while the remainder goes to charity after you die. This reduces your taxable estate and may provide an income tax deduction. These trusts are complex and work best for people with large estates and a strong commitment to charitable giving.

Understand which assets are taxable in your state

The six states with inheritance tax each have different rules about which assets are taxable and which are exempt. In most of these states, life insurance, retirement accounts, and certain savings accounts are exempt. Some states exempt property that passes to a spouse, parent, or child but tax property that passes to a sibling or unrelated person.

Pennsylvania, for example, does not tax inheritances to spouses, parents, or children, but does tax inheritances to siblings and others. Iowa exempts spouses, children, and grandchildren but taxes more distant relatives. New Jersey has no tax on spouses or lineal descendants but does tax siblings and others.

If you live in or own property in one of these six states, look up that state's specific rules or ask a tax professional. The exemptions and rates change occasionally, and knowing the current rules can help you plan which assets to leave to which people.

Work with a lawyer or tax professional

Inheritance tax planning involves legal documents like wills, trusts, and beneficiary designations. Mistakes in these documents can cost your heirs thousands of dollars. A lawyer who specializes in estate planning can review your situation, explain which strategies explore to you, and draft the documents correctly.

If your estate is large or complex — for example, if you own a business, property in multiple states, or have a blended family — professional help is especially important. A tax professional can also model different scenarios to show you how much tax your heirs would owe under each plan.

The cost of a lawyer or accountant is usually much less than the tax your heirs would save. Many estate planning lawyers charge a flat fee for a basic will and trust package, typically $1,000 to $3,000 depending on complexity and location.

Frequently Asked Questions

Do I have to pay inheritance tax if I live in a state that does not have it?

No. Inheritance tax only applies if you receive money or property from someone who died and that person lived in or owned property in one of the six states that have inheritance tax. If both you and the deceased lived in states without inheritance tax, you owe nothing.

Can I avoid inheritance tax by putting my house in my child's name?

Putting your house in your child's name during your lifetime can reduce your taxable estate, but it has serious drawbacks. You lose control of the property, your child may face capital gains tax when they sell it, and the property could be at risk if your child faces creditors or divorce. A revocable trust is usually a better option.

What happens to my inheritance tax if I move to a different state?

Inheritance tax is based on where the deceased person lived or owned property, not where you live. If you inherit from someone who lived in Maryland, you owe Maryland inheritance tax even if you live in California. However, if you move after inheriting, you do not owe tax in your new state.

Is life insurance subject to inheritance tax?

Life insurance proceeds are usually not subject to inheritance tax if the policy is owned by someone other than the deceased or if it passes directly to a named beneficiary. However, if the deceased owned the policy, the proceeds are part of the estate and may be taxable depending on the state and the beneficiary's relationship to the deceased.

Can I reduce my inheritance tax by giving money to my children every year?

Yes. Giving up to $18,000 per child per year reduces what your estate is worth when you die, which reduces the inheritance tax your heirs owe. This strategy works best if you have time — the more years you give, the more you can transfer. It also requires that you have income or savings beyond what you need to live on.