Inheritance Tax vs Estate Tax: State Rules & Planning Tips

Inheritance Tax vs Estate Tax: What Is the Difference?

The estate tax is paid by the deceased person's estate before assets are distributed to heirs. It is based on the total value of the estate. The federal estate tax exemption for 2026 is approximately $7 million per person (down from $13.61 million in 2025 due to the expiration of the Tax Cuts and Jobs Act provisions). Estates below this threshold owe no federal estate tax.

The inheritance tax is paid by the individual beneficiary who receives the inheritance. It is based on the value of what each person inherits and their relationship to the deceased. There is no federal inheritance tax; it exists only at the state level. Closer relatives (spouse, children) typically pay lower rates or are fully exempt, while distant relatives and unrelated beneficiaries pay higher rates.

A beneficiary could potentially owe both estate tax and inheritance tax on the same inherited assets if the estate is large enough for federal estate tax and the deceased lived in (or the beneficiary lives in) an inheritance tax state. Learn more about federal estate tax in our estate tax planning guide.

The Six States with Inheritance Tax

As of 2026, only six states impose an inheritance tax. The tax applies based on the state where the deceased person lived, not where the beneficiary lives (with some exceptions):

Note that Maryland is the only state that imposes both an estate tax and an inheritance tax. Iowa is phasing out its inheritance tax, with repeal effective January 1, 2025, for decedents dying on or after that date. Check your state's overall tax burden for the full picture.

How Inheritance Tax Rates Work by Relationship

Inheritance tax states categorize beneficiaries into classes based on their relationship to the deceased. Closer relatives pay lower rates or are fully exempt:

Class A (closest relatives): Spouse, children, grandchildren, parents. In most states, Class A beneficiaries are fully exempt. Pennsylvania is the notable exception, taxing children and grandchildren at 4.5%.

Class B (other relatives): Siblings, nieces, nephews, sons-in-law, daughters-in-law. Rates typically range from 4% to 12% depending on the state and amount inherited.

Class C/D (unrelated): Friends, business partners, and other non-family beneficiaries. These pay the highest rates, ranging from 10% to 18% depending on the state.

Federal Estate Tax vs State Estate Tax

Beyond the six inheritance tax states, 12 states plus the District of Columbia impose their own estate taxes (separate from inheritance tax). State estate tax exemptions are generally much lower than the federal exemption:

• Oregon: $1 million exemption, 10% - 16% rates
• Massachusetts: $2 million exemption, 0.8% - 16% rates
• New York: $6.94 million exemption (with cliff provision), 3.06% - 16% rates
• Washington: $2.193 million exemption, 10% - 20% rates (highest state rate)
• Connecticut: Matches federal exemption, 12% flat rate

The combination of federal estate tax, state estate tax, and inheritance tax can create a significant cumulative burden. In Maryland, for example, a large estate could face all three. Use our Income Tax Calculator to understand the income tax implications of inherited assets.

The Step-Up in Basis: A Major Tax Benefit

When you inherit assets, you receive a "stepped-up" cost basis equal to the fair market value at the date of the deceased's death. This means all unrealized capital gains accumulated during the deceased's lifetime are permanently eliminated for income tax purposes.

For example, if your parent bought stock for $10,000 and it was worth $200,000 when they died, your cost basis is $200,000. If you sell it for $205,000, you only owe capital gains tax on $5,000, not $195,000. This step-up applies to all inherited assets including real estate, stocks, and business interests. Learn more about capital gains in our capital gains guide.

Strategies to Minimize Inheritance and Estate Tax

Annual gift exclusion. You can give up to $18,000 per person per year (2026) without any gift tax or reporting. A married couple can give $36,000 to each child, grandchild, or other person. Over time, this transfers significant wealth out of the estate. Read our gift tax rules guide for details.

Irrevocable life insurance trust (ILIT). Life insurance proceeds are included in your estate if you own the policy. By placing the policy in an ILIT, the proceeds pass to beneficiaries free of estate tax. The trust must be created at least three years before death to avoid inclusion in the estate.

Leave assets to exempt beneficiaries. In inheritance tax states, structuring your estate plan to leave more to exempt classes (spouse, children in most states) and less to non-exempt classes can reduce the inheritance tax burden.

Consider domicile carefully. If you live in a state with inheritance or estate tax and are considering retirement in another state, moving to a tax-friendly state can eliminate state-level death taxes entirely. Florida, Texas, and Nevada have no estate or inheritance tax.

Charitable bequests. Assets left to charity are fully deductible from both the estate tax and most state inheritance taxes. A charitable remainder trust can provide income to heirs during their lifetime with the remainder going to charity, potentially reducing both income and estate taxes.

Income Tax on Inherited Assets

In general, inherited assets are not considered taxable income to the beneficiary. The inheritance itself is not reported on your income tax return. However, income generated by inherited assets after you receive them (dividends, interest, rent) is taxable. Additionally, inherited retirement accounts (401(k)s, IRAs) are taxable when distributions are taken, because the original owner received a tax deduction on contributions. Under the SECURE Act, most non-spouse beneficiaries must withdraw all funds from inherited IRAs within 10 years of the original owner's death.

Frequently Asked Questions

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