Estate tax is a federal tax on the total value of everything a person owns when they die

When someone passes away, the federal government may tax their estate—the money, property, investments, and possessions they leave behind. This tax applies only to estates above a certain dollar threshold, which changes every year. Most people's estates fall below that threshold and owe no federal estate tax at all. Some states also collect their own estate or inheritance taxes, which work differently and have lower thresholds.

The key thing to understand is that estate tax is separate from income tax or property tax. It is a one-time tax on the total value of what you owned at death, calculated before your heirs receive their inheritance. The executor of your estate (the person named to handle it) is responsible for figuring out whether the estate owes tax and paying it from estate assets before distributing money to beneficiaries.

Key Takeaways

  • Federal estate tax only applies to estates worth more than a threshold amount set by federal law, which is $13.61 million for deaths in 2024 and changes yearly.
  • The executor of an estate must file a federal estate tax return (Form 706) only if the estate exceeds the threshold, even if no tax is owed.
  • Some states impose their own estate or inheritance taxes with much lower thresholds, so you may owe state tax even if the federal threshold is not met.
  • Married couples can combine their thresholds through a process called portability, effectively doubling the amount that passes tax-free.
  • Common ways to reduce estate tax include giving money to charity, setting up trusts, and making annual gifts to family members during your lifetime.

The federal threshold and who actually pays estate tax

The federal estate tax threshold is adjusted each year for inflation. For deaths in 2024, an estate must be worth more than $13.61 million before any federal estate tax is owed. This means that if you die and your total assets are worth $10 million, your estate owes zero federal estate tax, even though you had a substantial estate.

Because the threshold is so high, only about 0.1% of estates in the United States owe federal estate tax in any given year. Most people will never encounter this tax. However, if you own a family business, significant real estate, or have accumulated substantial investments over a lifetime, your estate could exceed the threshold. The tax rate on amounts above the threshold is 40%, which is why people with large estates often work with an estate planning attorney or tax professional to reduce what their heirs will owe.

It is important to know that the threshold is set to drop significantly after 2025. Unless Congress changes the law, the threshold will fall to roughly $7 million per person (adjusted for inflation) starting in 2026. This means more estates could become subject to tax in the future, even if they would not be taxed under today's rules.

State estate and inheritance taxes work differently

Twelve states plus the District of Columbia currently collect their own estate taxes, and six states collect inheritance taxes. These are separate from federal estate tax. A state estate tax is similar to the federal version—it taxes the total value of the estate. An inheritance tax is different: it taxes the person who receives the money (the heir), not the estate itself, and the rate often depends on how closely related the heir is to the person who died.

State thresholds are much lower than the federal threshold. For example, Massachusetts has a state estate tax threshold of $1 million, and New York's is $6.94 million as of 2024. If you live in or own property in a state with an estate or inheritance tax, you may owe that state tax even if your estate is far below the federal threshold. The executor will need to file a state return in addition to any federal return.

If you own real estate in multiple states, you may owe estate tax in more than one state. This is one reason people with property in different states should work with an estate planning professional to understand their total tax exposure.

How the estate tax is calculated and paid

The executor begins by determining the gross estate—the fair market value of everything the person owned at the moment of death. This includes bank accounts, investment accounts, real estate, vehicles, life insurance proceeds, retirement accounts, and personal property. The executor then subtracts allowable deductions, such as funeral expenses, debts the person owed, and charitable gifts made through the will.

The result is the taxable estate. If this amount exceeds the federal threshold, the executor must file Form 706 (the federal estate tax return) with the IRS, even if no tax is ultimately owed. The return is due nine months after the date of death, though an extension can be requested. If tax is owed, it must be paid from estate assets before the remaining money is distributed to heirs.

Some assets pass outside the estate and are not subject to estate tax. These include assets held in a revocable living trust, property held as joint tenants with rights of survivorship, life insurance proceeds if the policy is owned by someone other than the deceased, and retirement accounts with named beneficiaries. Understanding which assets are included in the taxable estate is crucial for planning.

Strategies to reduce estate tax

People with large estates have several legal ways to reduce the amount subject to tax. One common method is portability, which allows a surviving spouse to use the unused portion of their deceased spouse's threshold. For example, if one spouse dies and uses only $5 million of their $13.61 million threshold, the surviving spouse can use the remaining $8.61 million in addition to their own threshold. This effectively doubles the amount a married couple can pass to heirs tax-free.

Another strategy is making annual gifts during your lifetime. You can give up to $18,000 per person per year (as of 2024) without using any of your estate tax threshold. Over time, these gifts reduce the size of your taxable estate. Gifts to charity are also deductible from the taxable estate, so some people use charitable giving as both a tax strategy and a way to support causes they care about.

Trusts are another tool. A bypass trust (also called a credit shelter trust) allows you to pass assets to heirs while keeping them out of the taxable estate of your surviving spouse. An irrevocable life insurance trust can own a life insurance policy so that the proceeds do not count as part of your estate. These strategies require professional help to set up correctly, but they can save substantial amounts in tax for large estates.

The difference between estate tax and inheritance tax

Estate tax and inheritance tax are often confused because they both occur after someone dies, but they work very differently. Estate tax is paid by the estate itself before heirs receive their money. Inheritance tax is paid by the person who inherits the money. The tax rate for inheritance tax often depends on the relationship between the deceased and the heir—a spouse or child may pay a lower rate than a distant relative or unrelated person.

Only six states currently use inheritance tax: Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. If you live in one of these states and inherit money, you may owe tax on what you receive. The executor of the estate will typically withhold the tax before distributing your inheritance, or you may receive a bill from the state. The rules vary by state, so it is important to understand your state's specific rules if you are expecting an inheritance.

When to talk to a professional about estate tax

If your estate is worth less than your state's threshold and well below the federal threshold, you likely do not need to worry about estate tax planning. However, if you own a business, significant real estate, or have accumulated substantial wealth, or if you live in a state with an estate or inheritance tax, talking to an estate planning attorney or tax professional is worthwhile. They can review your situation and recommend strategies that fit your goals and circumstances.

Even if you do not currently owe estate tax, the changing thresholds mean your situation could shift. An attorney can help you set up documents like a will or trust that will work well regardless of what the tax law becomes. They can also coordinate with your financial advisor and accountant to make sure your overall plan is tax-efficient.

Frequently Asked Questions

Do I have to pay estate tax if I leave money to my spouse?

No. There is an unlimited marital deduction, which means you can leave any amount to your spouse without owing federal estate tax. However, your spouse's estate will then include that money, so if their total estate exceeds the threshold, tax could be owed when they pass away. Some people use a bypass trust to avoid this problem.

What happens if the executor does not file an estate tax return when one is required?

The IRS can assess penalties and interest on unpaid taxes. The executor has a legal duty to file the return if the estate exceeds the threshold. If you are an executor and are unsure whether a return is required, consult a tax professional or attorney rather than guessing.

Can I reduce my estate tax by giving money to my children before I die?

Yes. Annual gifts up to $18,000 per person (as of 2024) do not count against your estate tax threshold. Larger gifts can count against your lifetime exemption, but you can still make them—you just use up part of your threshold. A tax professional can help you plan a gifting strategy that works for your situation.

Does life insurance count toward my estate for tax purposes?

Yes, if you own the policy. Life insurance proceeds are included in your taxable estate if you are the owner at death. However, if someone else owns the policy (such as a trust or your adult child), the proceeds are not part of your estate. This is why some people use an irrevocable life insurance trust.

What is the difference between federal and state estate tax?

Federal estate tax applies nationwide and has a high threshold ($13.61 million in 2024). State estate taxes are collected by individual states and have much lower thresholds. You may owe both if you live in a state with an estate tax and your estate exceeds that state's threshold. Some states also allow a credit for federal tax paid, which reduces the total burden.