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When a person passes away, taxes can be levied by the federal or state government on money and assets left to heirs. The first $12.06 million of a person's estate is exempt from federal taxes, but larger estates may be required to pay. Additionally, 12 states and Washington, D.C., have their own estate taxes, with thresholds as low as $1 million; another six states have inheritance taxes that can apply to gifts of any size. Here's how estate and inheritance taxes work—and when an estate might need to pay them.
How Do Estate Taxes Work?
When a person dies, the collection of assets they leave behind is called their estate. As part of the process of managing an estate, the estate administrator may file taxes on behalf of the deceased person, pay off debts, distribute assets and calculate the estate's taxable value to see whether estate taxes are due to the federal government or the state in which the deceased person lived.
What Makes Up a Person's Taxable Estate?
An estate's taxable value is the gross estate minus deductions plus taxable gifts. IRS Form 706 walks you through these calculations, but here's a quick explainer on some of these terms:
The gross estate equals the combined fair market value of cash and securities, real estate, insurance, trusts, annuities, business interests and other assets.
Deductions include mortgages and other debts, estate administration expenses and property that passes to surviving spouses and qualified charities. In some cases, adjustments may apply to qualifying business interests or farms.
Taxable gifts include money or the transfer of assets that exceeds the IRS' annual or lifetime limits on nontaxable gifts. For 2022, the annual limit is $16,000 per individual with a lifetime cap of $12.06 million.
The first $12.06 million of an estate's taxable value is tax-exempt. After that, the following federal estate tax rates apply:
|Federal Estate Tax Rates|
|Taxable Amount Over $12.06 Million||Tax Rate|
|$1 - $10,000||18%|
|$10,001 - $20,000||20%|
|$20,001 - $40,000||22%|
|$40,001 - $60,000||24%|
|$60,001 - $80,000||26%|
|$80,001 - $100,000||28%|
|$100,001 - 150,000||30%|
|$150,001 - $250,000||32%|
|$250,001 - $500,000||34%|
|$500,001 - $750,000||37%|
|$750,001 - $1,000,000||39%|
|$1,000,001 and up||40%|
What Are State Estate Taxes?
States may impose their own estate taxes. Where they apply, exemption thresholds are lower than they are for federal estate taxes. Here's where estate taxes are imposed and their 2022 tax rates:
|States With Estate Taxes|
|Connecticut||11.6% - 12% on estates above $9.1 million|
|District of Columbia||11.2% - 16% on estates above $4,254,800|
|Hawaii||10% - 20% on estates above $5.49 million|
|Illinois||0.8% - 16% on estates above $4 million|
|Maine||8% - 12% on estates above $6.01 million|
|Maryland||0.8% - 16% on estates above $5 million|
|Massachusetts||0.8% - 16% on estates above $1 million|
|Minnesota||13% - 16% on estates above $3 million|
|New York||3.06% - 16% on estates above $6.11 million|
|Oregon||10% - 16% on estates above $1 million|
|Rhode Island||0.8% - 16% on estates above $1,648,611|
|Vermont||16% on estates above $5 million|
|Washington||10% - 20% on estates above $2.193 million|
What Are State Inheritance Taxes?
Inheritance taxes are charged to heirs instead of the estate itself. State inheritance taxes apply in the state where the deceased person lived. If you lived in New York and inherited money from a person who lived in Kentucky, for instance, you would pay an inheritance tax to the state of Kentucky.
Inheritance tax rates may differ depending on the size of the inheritance and on the relationship of the heir to the person who has died. In Kentucky, for example, spouses, parents, children, grandchildren and siblings are exempt. Nieces, nephews, daughters-in-law, sons-in-law, aunts, uncles and great-grandchildren pay one set of tax rates, while all other heirs pay slightly higher rates. If you inherit anything from a person in one of the following states, check with the state taxing authority for details on what you might owe.
Only six U.S. states have inheritance taxes, and one—Iowa—is in the process of phasing out their inheritance tax. Here are the six states with inheritance taxes:
|States With Inheritance Taxes|
|Iowa||4% - 12%|
|Kentucky||2% to 16%|
|Nebraska||1% - 18%, with the top tax rate dropping to 15% in 2023|
|New Jersey||11% - 16%|
|Pennsylvania||4.5% - 15%|
How to Reduce Estate Taxes
The simplest way to reduce estate taxes is by keeping your estate value below the exemption threshold. For federal tax purposes, that's $12.06 million—far more than most Americans have at the time of their death.
If you have a large estate, you may want to consult an attorney or financial professional with experience in estate planning. They can help you structure an inheritance plan and manage your estate's taxable value through the strategic use of trusts, life insurance and business succession planning.
Broadly speaking, you can also reduce the size of your estate in three tried-and-true ways:
- Spend it. Travel to visit friends or host a family reunion if you'd rather enjoy your money than give it to the government when you're gone.
- Gift it. There is no tax consequence for gifting money or assets worth up to $16,000 per recipient in 2022. If your total lifetime gifts exceed $12.06 million in 2022, you may be subject to gift taxes, so be mindful and consult a pro if you'd like to transfer substantial assets to avoid paying estate taxes.
- Donate it. Give money or assets to charity to minimize the size of your estate. Again, an estate planning pro can help you maximize tax benefits and comply with IRS and state guidelines for giving.
Get Help When You Need It
Most estates don't exceed the $12.06 million IRS exemption for federal estate taxes. And, though estate and inheritance taxes may apply at the state level, many states don't impose them. If you're leaving behind a large estate, are administering an estate that may be subject to estate taxes or are receiving an inheritance in a state that imposes inheritance tax, be sure to read up on IRS and state guidelines.
When in doubt, get help from a knowledgeable estate planning attorney, financial advisor or tax professional: They can help you avoid overpaying while complying with state and federal law.