What inheritance tax is and who pays it

Inheritance tax is a tax on the money and property someone leaves behind when they die. The person who inherits it may owe tax on the value they receive—though the rules depend heavily on which state you live in and how much the estate is worth.

Not all states have an inheritance tax. As of now, about a dozen states impose one, and the tax rate and threshold (the amount you can inherit tax-free) vary by state. Some states tax only distant relatives or non-relatives; others don't tax spouses or children at all. The federal government also has an estate tax, but it only applies to very large estates—currently those worth more than around $13 million per person, though this threshold changes with tax law.

The key point: if you live in a state with no inheritance tax, or if your total estate is below your state's threshold, you may owe nothing. If you do owe tax, there are legal ways to reduce what your heirs pay.

Key Takeaways

  • Inheritance tax applies only in about a dozen states, and the threshold (the amount you can leave tax-free) varies widely—some states exempt spouses and children entirely.
  • The federal estate tax only affects estates worth more than roughly $13 million per person, a threshold that changes when tax law changes.
  • Giving money or property to family members during your lifetime can reduce your taxable estate, though federal gift tax rules explore above certain amounts.
  • Trusts, life insurance owned by a trust, and retirement account beneficiary designations can all keep assets out of your taxable estate.
  • A lawyer who specializes in estate planning can show you which strategies work in your state and for your specific situation.

Understand your state's rules before you plan

The first step is knowing whether your state taxes inheritance at all. States with inheritance tax include Iowa, Kentucky, Maryland, Nebraska, New Jersey, Pennsylvania, and a few others—the list has changed over time. If you live in one of these states, find out the tax rate and the threshold (how much each heir can inherit tax-free). These thresholds are often much lower than the federal threshold, and they vary by how closely related the heir is to the person who died.

For example, some states exempt spouses and children but tax more distant relatives at higher rates. Others have a single threshold regardless of relationship. Your state's department of revenue or taxation publishes this information, and an estate planning lawyer in your state can explain exactly how it applies to your situation.

If you live in a state with no inheritance tax, you still need to consider the federal estate tax if your estate is very large. Most people do not reach that threshold, but if you own a business, significant real estate, or substantial investments, it is worth checking.

Give money or property during your lifetime

One of the most straightforward ways to reduce your taxable estate is to give money or property to family members while you are alive. This removes those assets from your estate, so they are not taxed when you die. The federal government allows you to give a certain amount per person per year without triggering gift tax—currently $18,000 per recipient in 2024, though this amount adjusts annually for inflation.

You can also give larger amounts to your spouse or to pay someone's medical bills or tuition directly to the provider without counting against your lifetime gift limit. If you give more than the annual limit to one person, you file a gift tax return, but you do not owe tax unless you exceed your lifetime exemption (currently around $13 million).

This strategy works best if you have time and a clear plan. Giving away assets gradually over several years reduces your estate more efficiently than waiting until you are near death. It also lets you see your family benefit from the gifts while you are alive.

Use a trust to keep assets out of your taxable estate

A trust is a legal arrangement where you transfer assets to a trustee, who manages them for the benefit of your heirs. Depending on the type of trust, assets held in the trust may not be counted as part of your taxable estate when you die.

An irrevocable life insurance trust (ILIT) is one common example. You transfer a life insurance policy into the trust, and the death benefit goes to your heirs outside your taxable estate. This works because the insurance company pays the benefit directly to the trust, not to your estate. A regular revocable trust, by contrast, does not reduce your taxable estate because you retain control of the assets.

Other trusts, such as a may have access to personal residence trust (QPRT), let you live in your home for a set number of years and then transfer it to heirs at a reduced tax value. After the term ends, your heirs own the home, and its future appreciation is not part of your taxable estate.

Trusts are powerful tools, but they require careful drafting and ongoing administration. A lawyer who specializes in estate planning can recommend which type of trust makes sense for your situation and your state's laws.

Name beneficiaries on retirement accounts and life insurance

Money in retirement accounts (such as IRAs and 401(k)s) and life insurance proceeds pass directly to the named beneficiary and do not go through your estate. This means they are not subject to probate and, in most cases, not subject to inheritance tax.

The key is to name a beneficiary and keep that designation current. If you do not name a beneficiary, the account goes into your estate and may be taxed. If you name your estate as the beneficiary, the same problem occurs. Review these designations every few years, especially after major life changes like marriage, divorce, or the birth of children.

If you want to leave retirement account money to multiple heirs or to a charity, you can name the account beneficiary as a trust, though this requires careful drafting to avoid unintended tax consequences. A financial advisor or estate planning lawyer can help you set this up correctly.

Consider charitable giving strategies

If you plan to leave money to charity, certain structures can reduce your taxable estate while also providing you with income during your lifetime. A charitable remainder trust lets you transfer assets to a trust that pays you (or you and your spouse) income for life, and then the remaining assets go to a charity. The assets are removed from your taxable estate, and you get an income tax deduction in the year you create the trust.

A donor-advised fund is simpler: you donate money to the fund, receive an when ready tax deduction, and then recommend grants to charities over time. The money is out of your taxable estate right away, even though you have time to decide which charities to support.

These strategies work best if you have a genuine interest in charitable giving and a substantial amount to donate. They are not worth the complexity if you are giving small amounts or have no charitable intent.

Work with an estate planning lawyer in your state

Inheritance tax law is specific to each state, and the best strategy for your situation depends on how much you own, who you want to leave it to, and what your state's rules are. A lawyer who specializes in estate planning can review your situation, explain which strategies explore to you, and draft the documents you need.

This is not a do-it-yourself area. Online templates and generic wills may miss opportunities to reduce tax or may create problems for your heirs later. A lawyer's fee for basic estate planning (a will, possibly a trust, and beneficiary designations) typically ranges widely depending on your state and the complexity of your situation, but it is usually far less than the tax your heirs would pay without a plan.

If your estate is very large or your situation is complex (for example, you own a business, have children from multiple relationships, or have significant assets in more than one state), the value of professional guidance is even higher.

Frequently Asked Questions

Does my spouse have to pay inheritance tax on what I leave them?

In most states, spouses are exempt from inheritance tax entirely. However, this varies by state, so check your state's rules. At the federal level, there is no estate tax on assets left to a spouse who is a U.S. citizen, as long as the assets pass directly to the spouse (not through a trust that limits their control).

What if I move to a different state after I have already planned my estate?

Your estate plan should be reviewed by a lawyer in your new state, because inheritance tax rules, trust laws, and other requirements differ. A plan that works in one state may not work as well in another. You may need to update your will or trust, especially if you own real estate in the new state.

Can I reduce my taxable estate by putting my house in my child's name?

Putting your house in your child's name removes it from your estate, but it creates other problems. You lose the "step-up in basis" your heirs would get if you owned it when you died, which can cost them more in capital gains tax when they sell. You also lose control of the property and expose it to your child's creditors. A trust is usually a better way to handle real estate.

What happens if I give away too much money during my lifetime?

If you give more than the annual limit ($18,000 per person in 2024) to one person, you file a gift tax return, but you do not owe tax unless you exceed your lifetime exemption (around $13 million). However, amounts over the annual limit count against your lifetime exemption, which reduces the amount you can leave tax-free when you die. For most people, this is not a problem, but it is worth tracking if you are giving large gifts.

Is an online will or trust template enough to reduce my inheritance tax?

Online templates can create a valid will, but they rarely include the tax-reduction strategies that a lawyer would recommend. Trusts, in particular, require careful drafting to work as intended. If your goal is to reduce inheritance tax, a lawyer's review is worth the cost.