The Differences Between Estate Tax and Inheritance Tax

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While the terms "estate tax" and "inheritance tax" are often used interchangeably when referring to taxes collected after someone dies, these two terms refer to two completely different types of death taxes.

Currently, only a handful of states and the District of Columbia collect estate taxes at the state level, while only six states collect inheritance taxes at the state level, and two states - Maryland and New Jersey - collect both. So what is the difference between an estate tax and an inheritance tax?

What Estate Tax Is

An estate tax is a type of death tax that is calculated based on the net value of property owned by a deceased person on the date of death.

All of the jurisdictions that currently collect a state estate tax give their residents and nonresidents who own real estate or tangible personal property located in the state an exemption from the state estate tax. These exemptions range from a low of $675,000 in New Jersey to a high of $5,340,000 in Delaware and Hawaii, with most states only offering a $1,000,000 exemption.

Refer to the State Estate Tax and Exemption Chart for information about the following jurisdictions that collect state estate taxes and their current state estate tax exemption amounts - Connecticut, Delaware, District of Columbia, Hawaii, Illinois, Maine, Maryland, Massachusetts, Minnesota, New Jersey, New York, Oregon, Rhode Island, Tennessee, Vermont, and Washington.

What Inheritance Tax Is

Contrast an estate tax with an inheritance tax, which is a type of death tax that is calculated based on who receives a deceased person's property.

In other words, an estate tax is based on the overall value of the estate and so the tax will be collected only if the value exceeds the estate tax exemption after applicable deductions are applied. On the other hand, an inheritance tax will only be collected if the estate passes to someone who is subject to the inheritance tax in the first place.

In all six of the states that collect an inheritance tax transfers to surviving spouses are completely exempt from the tax, while in four of the six states (Iowa, Kentucky, Maryland and New Jersey) transfers to surviving children and grandchildren are completely exempt from the tax. This means that in Nebraska and Pennsylvania, property passing to children and grandchildren or more collateral heirs, such as brothers and sisters or nieces and nephews, or friends will be subject to the state inheritance tax.

The Bottom Line on Estate Taxes and Inheritance Taxes

So what do you really need to know about the differences between a state estate tax and a state inheritance tax?  While a person in a state that collects an inheritance tax could choose their individual heirs very carefully so as to avoid the state inheritance tax altogether (such as excluding brothers and sisters or nieces and nephews or friends as heirs), this is not possible in a state that collects a state estate tax.

Note that Indiana repealed its state inheritance tax effective January 1, 2013, but for deaths that occurred before this date, an Indiana estate may be subject to the Indiana inheritance tax: Overview of Indiana Inheritance Tax Laws - 2012.

Refer to the State Inheritance Tax Chart for a summary of the inheritance tax laws in the following states that currently collect an inheritance tax - Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania.

NOTE: State laws change frequently and the following information may not reflect recent changes in the laws. For current tax or legal advice, please consult with an accountant or an attorney since the information contained in this article is not tax or legal advice and is not a substitute for tax or legal advice.