Estate tax vs. inheritance tax: Who pays & in which states?

Over your lifetime, you work to build a legacy you're proud of. There's no reason for that legacy to end when you pass away. To keep it going, you can transfer your wealth to your loved ones after you die.

You have a variety of ways to do so, but you may want to think through how taxation factors into your plans. Consider estate tax vs. inheritance tax: Each can affect what you leave to your heirs but in different ways. It's advantageous to know how they work as you plan the future of your legacy.

Whether you intend to pass on money, property or a business to your loved ones, here's what you need to know about the basic potential tax implications.

Both inheritance taxes and estate taxes are referred to as "death taxes." Although both may apply to you, they are distinctly different in how they are applied:

• An estate tax is levied against your estate, or the whole of what you own when you die. It's based on the total value of your cash, investments, property and other assets.
• An inheritance tax is levied against your beneficiaries, or those who received something from you upon your death. It's based on what they inherited and their relationship to you.

The federal government has an estate tax but not an inheritance tax. Individual states may have an estate tax, an inheritance tax, neither or both (currently, only Maryland has both). The taxation imposed varies based on where you lived and owned property—where your beneficiaries live doesn't matter.

Only very wealthy taxpayers need to be concerned about the federal estate tax. It applies to the portion of an estate that exceeds a specific lifetime exemption level. For 2024, your estate has to be worth more than $13.61 million for it to apply. For a married couple, it's a combined exemption of $27.22 million.

If your estate exceeds that limit, then the federal tax rate you'll face ranges from 18% to 40% of the value of your estate that's above the lifetime exemption amount.

Like the federal tax, states that have an estate tax only apply it to the portion of an estate that goes above a specific amount. Both the exemption amount and the taxation rate vary by state. Currently, only 12 states and the District of Columbia impose an estate tax:

When it comes to inheritance taxes, the state where you lived or owned property is what matters—not the beneficiary's residence. For example, if you live in Texas (a state with no income or estate tax) and leave money or property to a family member who lives in New Jersey (a state with an inheritance tax), your family member won't have to pay taxes on their inheritance because it's dictated by Texas' tax rules, not New Jersey's.

Currently, only six states impose an inheritance tax:

* Iowa is phasing out its inheritance tax and is aiming to eliminate it entirely by 2025.

Another important factor in calculating inheritance tax is the relationship between you (as the deceased) and the beneficiary. All six states with an inheritance tax don't levy it on surviving spouses. Iowa, Kentucky, Maryland and New Jersey also exempt transfers to surviving children and grandchildren. Other states generally tier their inheritance tax rates depending on the relationship, with non-related beneficiaries paying the highest rates.

One tax you don't need to be concerned about your heirs being responsible for—at least initially—is a capital gains tax on property or assets that have increased in value since your purchase. Capital gains tax usually kicks in when you sell something for a higher price than its basis, which is typically the price you paid for it. For example, if you buy $100 of stock and later sell those shares for $150, you'll owe capital gains tax on the $50 increase.

For inherited assets, however, the IRS applies a rule called "stepped-up basis" to assets such as investments, stocks, bonds or real estate. This means your beneficiary's basis in the property is its value at the time of the account owner's death rather than its original purchase price. This does not apply to IRA, 401(k), pensions, taxed-deferred annuities and money market accounts.

Understanding the difference between death tax vs. estate tax is just one aspect of figuring out how to distribute your assets after you're gone. Managing the details of your assets now can help you better estimate what your estate and heirs might be dealing with later.

To help make sure you and your beneficiaries are prepared, consider working with an estate attorney who's familiar with your state's rules. They can work in partnership with a financial advisor to look at your unique situation and provide guidance on how your assets can make the biggest possible impact after your death.