As the old saying goes, death and taxes are inextricable. What about death taxes? Can they be avoided? Taxes are part of daily life in America—from sales tax to gasoline tax to the FICA tax. There’s also income taxes, property taxes, sin taxes… the list goes on and on. The average American spends 29.2 % of their income on taxes each year, according the the Debt.org.
Your heirs could end up being taxed once again, even though you already give the government more that 29 cents for every dollar you earn in your lifetime.
Depending on what state you live in, your heirs or your estate can get hit with a death tax bill—either an inheritance or an estate tax. Or vice versa, you can get hit with a death tax bill if you receive assets from a family member or friend’s will.
What are Inheritance Taxes and Estate Taxes, and How Do They Work?
Wealth transfer after death is affected by inheritance and estate taxes. They are basically the same thing, but the only difference is who pays them.
According to InvestopediaAn inheritance tax is levied on anyone who receives assets from an estate of a deceased individual. An estate tax is imposed on the actual estate, before assets are distributed.
These taxes have a reputation of being the last twist of the taxman’s knife, since they are imposed on your assets or heirs after you die.
Inheritance and estate taxes—aka “death taxes”—have been legislated in a number of states across the country. There is no estate tax at the federal level. But that won’t be an issue for 99.9 percent of us.
The federal estate tax exempts assets up to $11.7 million for an individual and $23.4 millions for a married couple. It doesn’t kick in until after those levels, and the federal estate tax can have a rate as high as 40 percent. The idea behind the federal estate tax was to prevent tax-free wealth in perpetuity among America’s wealthiest families.
Instead of dealing with the IRS, the inheritance and estate taxes that non-multimillionaires encounter are at the state level. Each state has its own rules. Depending on the inheritance size, each beneficiary may have a different tax bill.
This is because inheritance tax rates also depend on the beneficiary’s relationship to the deceased, not just the state they are in. There are some types of relationships that are exempt from inheritance tax in each state.
These States Don’t Collect Death Taxes
There are 32 states where there is no death-related tax. There are no estate or inheritance taxes on wealth transfer if you and your beneficiaries reside in any of these 32 states. These include:
Alabama, Alaska, Arizona, Arkansas, California, Colorado, Delaware, Florida, Georgia, Hawaii, Idaho, Indiana, Kansas, Louisiana, Michigan, Mississippi, Missouri, Montana, Nevada, New Hampshire, New Mexico, North Carolina, North Dakota, Ohio, Oklahoma, South Carolina, South Dakota, Tennessee, Texas, Utah, Virginia, West Virginia, Wisconsin, Wyoming.
If you are a resident of one of these states, and inherit a home or business in a death-taxed area, an inheritance or estate taxes might still apply.
The State Details
16 states and Washington, D.C. currently have inheritance or estate taxes. Only five have inheritance taxes—New Jersey, Nebraska, Iowa, Kentucky, and Pennsylvania. This number will fall to four in 2025, as Iowa has eliminated its inheritance tax.
Twelve states have an estate taxes: Washington, Oregon. Minnesota. Illinois. New York. Maine. Vermont. Rhode Island. Massachusetts. Connecticut. Hawaii. Maryland is the only one that has an estate tax. both an estate tax and an inheritance tax.
Massachusetts and Oregon have the lowest thresholds for estate taxes. They levy taxes on all estates exceeding $1 million.
Washington, with 20 percent estate tax, is the most expensive. However, it’s only applied to the portion of an estate’s value greater than $11,193,000.
Organization Is Key
When you know that you will be receiving an inheritance—or if you are planning for your retirement and don’t want your kids getting hit with a massive tax bill—organization is key. Wealth transfers can be a great blessing. But if they aren’t planned for properly, they can end up leaving a huge tax burden.
Holding an intergenerational family meeting with an estate planner and legal advisor—when everyone is healthy and in good spirits—is a smart move. They can discuss with everyone the implications for wealth transfer in each of the states where assets are held. Then you and your family will be able to plan accordingly.
Trying to discuss financial matters while in mourning isn’t wise. This topic requires planning, research, and consultation with professionals.
Planning for death taxes
As you build wealth and plan for retirement, it is a good idea to include a strategy to avoid death taxes. Options such as establishing a trust or donating to charity can help you and your family avoid probate courts and minimize disputes.
There is no one-size fits all approach to wealth transfer planning and retirement planning. However, putting together a plan for your assets to end up with the most important people and causes in your life—instead of with the taxman—is a smart financial move. Particularly if you or your beneficiaries live in a death-tax state.