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Federal Estate Tax Explained

The federal estate tax applies only to estates exceeding the exemption threshold, which is $13.61 million per individual in 2026. With proper planning, married couples can shelter up to $27.22 million from federal estate tax through portability. The top federal estate tax rate is 40% on amounts above the exemption. This means the vast majority of American estates pay zero federal estate tax. However, the exemption is scheduled to be cut roughly in half at the end of 2025 under current law absent Congressional action, making planning especially important for estates in the $7 to 14 million range.

State Estate and Inheritance Taxes

Twelve states plus Washington DC levy their own estate taxes, often with lower exemption thresholds than the federal tax. Massachusetts and Oregon tax estates above $1 million. Washington State taxes estates above $2.193 million. Six states levy inheritance taxes on recipients rather than estates: Maryland, Nebraska, New Jersey, Kentucky, Pennsylvania, and Iowa. Inheritance tax rates and exemptions vary significantly by state and by relationship to the deceased. Spouses are typically exempt from inheritance tax in all states, while distant relatives and non-relatives face the highest rates.

Strategies to Minimize Estate Taxes

Several legal strategies reduce estate tax exposure. Annual gifts of up to $18,000 per recipient in 2026 (the annual exclusion) reduce the estate without using the lifetime exemption. Irrevocable life insurance trusts (ILITs) keep life insurance proceeds outside the taxable estate. Charitable giving reduces the estate while supporting causes you value. Family limited partnerships can reduce the taxable value of business interests. Qualified personal residence trusts transfer home value at a discount. Strategic spending during lifetime on experiences and gifts reduces the estate legally and intentionally. Work with an estate planning attorney for strategies appropriate to your specific situation.

Does everyone pay inheritance tax?

Most Americans pay no federal estate tax because the exemption threshold of $13.61 million in 2026 is above the vast majority of estates. State estate taxes affect more people in the 12 jurisdictions that levy them, particularly in states with low exemptions like Massachusetts at $1 million. Inheritance taxes in the six states that levy them affect beneficiaries not estates, and rates vary by relationship to the deceased, with spouses typically exempt and distant relatives facing higher rates.

How is inherited money taxed?

Assets inherited from an estate generally receive a step-up in basis to the fair market value at the date of death, which eliminates capital gains tax on appreciation during the deceased’s lifetime. If you inherit stocks worth $100,000 that the deceased bought for $10,000, you pay no capital gains tax on the $90,000 gain. You only pay capital gains tax on appreciation after you inherit the asset. Inherited traditional IRAs and 401k accounts do not receive the step-up and are taxed as ordinary income when withdrawn following required distribution rules.

What is the best way to pass wealth to heirs?

The optimal wealth transfer strategy depends on the size of your estate and your goals. For most Americans below the estate tax threshold, the primary considerations are ensuring assets transfer smoothly through beneficiary designations and a will, minimizing probate costs and delays through proper titling and trusts, and managing income tax implications for heirs especially inherited retirement accounts. For larger estates, work with an estate planning attorney and tax advisor to implement strategies that minimize both estate and income taxes while achieving your legacy goals.