What Is the Difference Between Estate Tax and Inheritance Tax?

When someone passes away, their assets—such as money, property, and investments—may be subject to taxation before they are transferred to heirs. Two common types of taxes that can apply are estate and inheritance tax. While they may seem similar, these taxes function differently and can impact beneficiaries in distinct ways.

Below, we’ll cover the key differences between estate tax and inheritance tax, including who pays, where they apply, and how they are calculated. However, tax laws can be complex and vary by state, so it’s always best to consult a tax or estate planning expert for guidance on your specific situation.

What Is Estate Tax?

Estate tax is a tax levied on the total value of a deceased person’s estate before the assets are distributed to heirs. This tax is paid by the estate itself, not by the beneficiaries.

How Estate Tax Works

• The estate's total value is calculated, including real estate, investments, bank accounts, and other assets.
• The government applies an estate tax based on the value that exceeds a certain exemption threshold.
• After the tax is paid, the remaining assets are distributed to heirs.

Federal vs. State Estate Tax

• The federal estate tax applies only to estates exceeding a certain exemption amount. As of recent years, this threshold is quite high, meaning most estates do not owe federal estate tax.
• Some states impose their own estate taxes, often with lower exemption limits than the federal threshold.

What Is Inheritance Tax?

Unlike estate tax, inheritance tax is paid by the heirs who receive assets, rather than by the estate itself. This tax is imposed at the state level, meaning only a handful of states currently enforce it.

How Inheritance Tax Works

• The tax applies to individuals who inherit money, property, or other assets.
• The amount owed depends on the heir's relationship to the deceased—closer relatives often receive lower tax rates or exemptions, while distant relatives or non-relatives may pay higher rates.

Federal vs. State Inheritance Tax

• There is no federal inheritance tax, so heirs do not owe taxes on inherited assets at the national level.
• Some states impose inheritance tax, with rates and exemptions varying by location. States that currently collect inheritance tax include Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania.1

Key Differences Between Estate and Inheritance Tax

1. Who Pays

Estate tax is paid by the estate before any assets are distributed to heirs, while inheritance tax is paid by the individuals receiving the assets. This means that with estate tax, the burden falls on the deceased’s estate, but with inheritance tax, the responsibility shifts to the heirs.

2. Where They Apply

Estate tax exists at both the federal and state levels, with the federal government imposing a tax on estates exceeding a certain exemption threshold. Some states also have their own estate taxes with lower exemption limits. Inheritance tax, on the other hand, is only imposed in a few states, and the federal government does not collect it.

3. How They’re Calculated

Estate tax is based on the total value of the estate before assets are distributed. If the estate exceeds the exemption limit, a tax is applied to the portion above that threshold. Inheritance tax is based on the amount each heir receives, and the rate often depends on their relationship to the deceased. Spouses are usually exempt, while distant relatives and non-relatives may pay higher rates in states that impose inheritance tax.

4. Who Is Affected the Most

Estate tax primarily impacts large estates, as it applies before any distribution takes place. Inheritance tax affects heirs individually, with closer family members often receiving exemptions or lower rates, while non-relatives and distant heirs may face higher taxes.

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Source:

1. Nolo. Inheritance Tax: Which States Have It and How It Works.