What is inheritance tax?

If you’ve embarked on your estate planning journey, you know there are many factors to consider when determining your legacy—and inheritance tax might be one of them. Inheritance tax is a state-level tax that beneficiaries pay when they inherit assets from someone who has died. It may be levied on property, investments and/or money that’s left to heirs.

Spouses are typically exempt from inheritance tax, as are some other “close” relatives. More distant relatives from the deceased individual, like nieces, nephews and cousins, may be subject to the inheritance tax, and most non-relatives will have to pay the tax. In most cases, inheritance tax is determined based on those relationships and not on the actual amount of money or property being transferred to the heir.

“Inheritance tax is assessed on beneficiaries or heirs in the receipt of property,” says Adonis Caneris, senior vice president and wealth trust advisor at U.S. Bank. “There are exemptions based on relationships—for example, spouses, children and other close relatives may be exempt—but the further you move away from those relationships, the higher the odds that the tax may be assessed.”

Note that there is no federal inheritance tax.

How does inheritance tax work?

Not all states levy inheritance tax, and individual states have their own exceptions and exemptions. Non-exempt transfers may trigger an inheritance tax in the state where the decedent (the person who died) lives, not where the beneficiary lives. Non-resident decedents owning real estate or other forms of tangible personal property may also be subject to inheritance tax.

Here’s how inheritance tax works:

• Inheritance tax is a state tax that beneficiaries must pay when they receive the assets generally using date of death valuations. Personal representatives are generally required to file the tax return and ensure the tax is paid.
• This is not to be confused with estate tax, which is a federal tax collected on the estate of the deceased in connection with the transfer of assets when an individual passes away.
• Inheritance tax returns and tax bills are typically due within several months of the decedent's death.

Which states have inheritance taxes?

Currently, six states levy inheritance taxes, one of which is phasing it out. Here are the states and their top inheritance tax rates:

• Iowa is phasing out its inheritance tax and planning to fully repeal it by 2025. The state’s current inheritance rate is on a sliding scale from 0% to 6%.
• Kentucky’s inheritance tax rate ranges from 0% to16%.
• Maryland’s inheritance tax rate ranges from 0% to10%.
• Nebraska’s inheritance tax rate ranges from 0% to 15%.
• New Jersey’s inheritance tax rate ranges from 0% to16%%.
• Pennsylvania’s inheritance tax rate ranges from 0% to 15%.

Whether an inheritance tax is levied and at what rate depends on the property that’s changing hands, the recipient’s relationship to the decedent, and where the latter owned the property or lived. The applicable exemption and the actual rate charged depends primarily on the recipient’s relationship to the decedent.

It’s worth noting that most states exempt charities from the inheritance tax.

How to reduce or eliminate inheritance tax

According to Caneris, inheritance tax applies to assets domiciled in a state that levies the tax. The tax is usually levied on the assets that the heirs receive, although most states allow the estates themselves to pay the tax on the heir’s behalf.

Terry Ruhe, senior vice president and regional trust manager at U.S. Bank, says moving to a state that doesn’t impose inheritance tax is one obvious way to avoid the tax. And because only six—soon to be five—states use the tax, relocation opportunities are plentiful.

“Some clients have moved to a different state if inheritance taxes are a concern,” says Ruhe.

Individuals can also use gifting as an inheritance tax mitigation strategy. In 2024, the annual gift tax exclusion is $18,000 per recipient. It’s important to note that some states have clawbacks or “deathbed gifts” that may be added back into the decedent’s estate at his or her time of death.

“Normally, federal annual exclusion gifting can help offset inheritance tax,” Caneris explains. “However, some states do have clawbacks that could come into play if someone dies within two to three years of making the gift.”

Another option is to establish an irrevocable trust, which you can use to set aside property and investments for beneficiaries that might otherwise be subjected to inheritance taxes. Certain types of property such as life insurance not payable to the estate may also be exempt and can be used as a planning tool.

When it comes to inheritance tax, be proactive

If you live in a state that collects inheritance tax, the rules may seem daunting and complex. The good news is that there are some proactive steps that you can take now to protect your wealth and ensure that your heirs get their rightful inheritance.

Understanding types of property, who your beneficiaries are and how those relationships are treated through the inheritance tax lens can help you better manage this potential tax. And be sure to consult with knowledgeable tax and financial professionals to learn the full scope of this tax’s effects, plus any strategies that you can use to protect your assets.

Learn about trust and estate services at U.S. Bank.