Yes, death can be a tax-triggering event. And there are two you should be aware of: the estate tax and inheritance tax.
Many people think they’re the same, but they aren’t.
The estate tax is levied on the things the deceased owns or has certain interests in when they die. The inheritance tax is paid by the heirs.
The federal government has an estate tax only, but states can have one, both, or none, which can make death taxes even more confusing.
Most people probably won’t have to pay these taxes because thresholds are high. In 2019, for example, only 6,409 federal estate tax returns were filed. Of those, only about 40% were taxable but the revenue garnered was $13.2 billion, IRS data show. However, the Congressional Budget Office expects that revenue "to increase sharply after 2025, when the amount exempt from estate tax is scheduled to drop" in half due to the expiration of the Tax Cuts and Jobs Act.
So, it's better to know how these taxes work in case you hit the thresholds.
What is the difference between inheritance tax and estate tax?
◾ Estate tax is "a tax on your right to transfer property at your death," the IRS says. They're paid by the estate of the person who died before assets are distributed.
◾ Inheritance tax is levied on someone who’s inherited money, property, or other assets. It only applies when the person who dies and passes on assets lived in one of the states that have an inheritance tax. It's not dependent on where the beneficiary lives.
Who levies the estate tax?
The federal government levies this tax, but a dozen states and the District of Columbia do too.
Federal tax rates range between 18% and 40%, depending on the amount above the $12.92 million threshold, or exemption amount, per person in 2023 or $13.61 million in 2024. For each tax tier, you pay a base tax charge and an additional marginal rate.
State estate tax rules differ from state to state, but exemption levels and the top tax rates are usually much lower than the federal government’s. For example, Oregon’s exemption is only $1 million.
No, there’s no federal inheritance tax, so your inheritance doesn’t have to be reported to the IRS.
However, any gains from the estate between the time the person died and when the amount is distributed to you, will have to be reported and taxed on your personal tax return, said Brian Schultz, partner at certified public accounting firm Plante Moran.
Gains could include dividends from any stocks or bonds you may have inherited, for example.
Only six states have an inheritance tax, but that will be cut to 5 next year as Iowa drops its tax.
Tax rates vary depending on the state but range between less than 1% to as high as 20% and usually apply to the amount above an exemption threshold. Rates depend on the size of your inheritance, state tax laws and your relationship with the deceased.
Generally, the closer you are to the deceased, the less likely you’ll have to pay this tax. Spouses are always exempt from paying inheritance tax, and immediate family members like children, and parents are often exempt, too, or pay a lower rate.
Maryland is the only state to impose both an estate tax and an inheritance tax.
How can you avoid these taxes?
The best way to avoid the inheritance tax is to manage assets before death. To eliminate or limit the amount of inheritance tax beneficiaries might have to pay, consider:
◾ Giving away some of your assets to potential beneficiaries before death. Each year, you can gift a certain amount to each person tax-free. In 2023, that annual gift exclusion was $17,000 and increased to $18,000 in 2024. These gifts are separate and in addition to your 2023 lifetime $12.92 million estate tax exemption.
◾ Moving to a state without an inheritance and estate tax. Federal estate tax may still be applicable though if your estate exceeds the exemption threshold.
◾ Setting up an irrevocable trust. You give up some control over the assets because the trust becomes the official owner, and you can’t change or cancel it. But no trust assets transfer upon death, so no estate or inheritance taxes are charged. Assets you think will appreciate are particularly good candidates for a trust because “the appreciation escapes tax,” said Scott Goldberger, principal of estate and trust at accounting firm Kaufman Rossin.
What if I can’t avoid the inheritance tax?
If, for some reason, you can’t avoid the inheritance tax but your heirs will be short on cash to pay (the bill usually is due within several months), consider buying a small, term life insurance policy, which has a death benefit that can cover the tax bill, said Dimitri Pan, wealth adviser at financial services firm Ally.
Medora Lee is a money, markets, and personal finance reporter at USA TODAY. You can reach her at mjlee@usatoday.com and subscribe to our free Daily Money newsletter for personal finance tips and business news every Monday through Friday.
