There are two types of taxes that can be assessed against your property once you pass away—estate taxes and inheritance taxes. The federal government imposes only an estate tax, but some states collect one or the other, or in some cases, both. Collectively, they're often referred to as death taxes.
The name "death tax" was coined years ago to put a negative spin on the federal estate tax. But although they're both death-related, they're actually quite different, which is why it's important to clearly understand what each tax is. Here is a quick guide below so to help you distinguish them.
- A death tax technically has no legal basis, but is essentially any tax that's imposed on the transfer of property after someone's death.
- An estate tax is a tax on your right to transfer property after your death and can be enacted at the federal or state level.
- As of 2021, the District of Columbia and 12 states impose a state estate tax separate from that of the federal government, while six impose both estate and inheritance tax.
What Is a Death Tax?
The phrase "death tax" is commonly used by the media to refer to an estate tax, an inheritance tax, or both. It has no legal basis, so legislatively speaking, it doesn't really exist.
The death tax can be any tax that's imposed on the transfer of property after someone's death, whether that tax is based on the total value of the decedent's estate or the value of a single bequest.
Although beneficiaries are responsible for paying the inheritance tax while estates pay the estate tax, many estates step in to take this financial burden off their beneficiaries and they pay it for them. It's a personal decision, not a legislative one, and is often provided for in a decedent's will.
What Is an Estate Tax?
An estate tax is a tax on your right to transfer property after your death and accounts for everything you own or have certain interests in at the date of death. This type of tax can be imposed at the state or the federal level. The government charges it on your right to transfer your property to your heirs after your death.
As of 2021, the District of Columbia and 12 states impose a state estate tax separate from that of the federal government: Connecticut, Hawaii, Illinois, Maine, Maryland, Massachusetts, Minnesota, New York, Oregon, Rhode Island, Vermont, and Washington. Both the Delaware and New Jersey estate taxes were eliminated on January 1, 2018.
This tax generally isn't levied against the entire value of an estate but only on the amount by which it exceeds certain thresholds called exemptions.
For decedents dying in 2021, the federal estate tax exemption is $11.7 million (and increasing to $12.06 million in 2022) due to changes stemming from the Tax Cut and Jobs Act (TCJA), so this much of every estate can pass tax-free. It will sunset in 2025 unless Congress chooses to renew it. If not renewed, it will revert back to $5 million, indexed for inflation.
Many states match this exemption, but in some, the thresholds are far lower. For example, the exemption in Oregon is only $1 million.
What Is an Inheritance Tax?
The federal government doesn't impose an inheritance tax but several states do. An inheritance tax is mandated by a state government and is assessed on individual bequests, not an entire estate, by the state in which the decedent lived or where they owned property.
As of 2021, six states collect an inheritance tax: Iowa, Kentucky, Nebraska, New Jersey, Pennsylvania, and Maryland, with the latter also collecting estate tax. Indiana's inheritance tax, meanwhile, was repealed effective January 1, 2013, and Iowa plans to do the same by Jan. 1, 2025.
Property left to a surviving spouse is exempt from the tax in all six states, but not all of those states exempt transfers to descendants. This tax is to be paid by the beneficiaries based on a percentage of the value of their inheritance.
State and federal laws change frequently and this information may not reflect recent changes. For current tax advice, please consult with an accountant or an attorney. The information contained in this article is not tax or legal advice and is not a substitute for tax or legal advice.