Estate tax is a federal tax on the total value of everything a person owns when they die
The federal government taxes large estates — the money, property, investments, and other assets someone leaves behind. The tax applies to the estate itself, not to the people who inherit it. Your state may also have its own estate tax, separate from the federal one, with different rules and thresholds.
Not every estate pays this tax. The federal government sets a threshold amount each year. Estates below that threshold owe nothing. Estates above it owe tax on the amount over the threshold. The threshold changes annually and is set by Congress, so the number that triggers a tax bill is different each year.
The person managing the estate — usually called the executor or personal representative — is responsible for filing the tax return and paying what is owed. This happens after the person dies, using the value of the estate on the date of death.
Key Takeaways
- Federal estate tax applies only to estates larger than an annual threshold set by Congress, which changes each year.
- The tax is paid by the estate itself before money and property are distributed to heirs, not by the people who inherit.
- Most states do not have an estate tax, but some do, and state thresholds are often much lower than the federal threshold.
- The executor or personal representative files the estate tax return and arranges payment using estate assets.
- Planning strategies like trusts, gifts during life, and charitable donations can reduce or eliminate estate tax for large estates.
Federal threshold and how it changes year to year
The federal estate tax threshold is not a fixed number. Congress sets it, and it adjusts each year based on inflation. In recent years, the threshold has been in the millions of dollars, meaning only estates worth several million dollars or more trigger a federal tax bill.
Because the threshold is high, most people's estates do not owe federal estate tax at all. The executor still has to file a return if the estate is large enough, but many estates below the threshold file and owe nothing.
The threshold is scheduled to change significantly in a future year set by Congress. When that date arrives, the threshold will drop unless Congress votes to extend the current rules. This means an estate that owes no tax today might owe tax in the future if the threshold falls and the estate is still large enough to cross it.
State estate taxes and how they differ from federal tax
Twelve states and the District of Columbia currently have their own estate taxes. These are separate from the federal tax. A state estate tax applies to estates in that state, using that state's own threshold and tax rate.
State thresholds are often much lower than the federal threshold. Some states tax estates worth $1 million or more, while others set the threshold higher. If you live in a state with an estate tax and your estate is large enough, you may owe both state and federal tax.
A few states have an inheritance tax instead of an estate tax. An inheritance tax is paid by the people who inherit, not by the estate. The rules, thresholds, and rates are different from state to state. If you own property in multiple states, you may need to understand the rules in each one.
What gets counted in an estate's value
An estate includes everything the person owned at death: a house, bank accounts, retirement accounts, investments, vehicles, jewelry, life insurance proceeds, and business interests. It also includes money owed to the person and the value of certain trusts.
Some assets pass outside the estate and are not counted for tax purposes. Money left in a payable-on-death bank account, for example, goes directly to the named beneficiary and does not go through the estate. Life insurance with a named beneficiary other than the estate also passes outside the estate. Retirement accounts with named beneficiaries work the same way.
The value used for tax purposes is the fair market value on the date of death — what the asset would sell for on that day, not what was paid for it years ago. A house bought for $200,000 twenty years ago might be worth $600,000 at death, and that higher number is what counts toward the estate tax threshold.
How the tax is calculated and paid
If an estate is above the threshold, the tax is calculated on the amount over the threshold, not on the entire estate. The tax rate is a flat percentage set by federal law. The executor files Form 706 with the IRS, reports the estate's value, calculates the tax owed, and pays it from estate assets.
The estate tax return must be filed within nine months of death, though an extension can be requested. The executor uses money from the estate to pay the tax bill before distributing the remaining assets to heirs. This means heirs may receive less than they would have if no tax were owed.
Some estates use life insurance or other strategies to cover the tax bill without forcing the sale of property or other assets. A tax professional or estate attorney can help the executor understand the options.
Common ways to reduce estate tax
People with large estates often use legal strategies to reduce or eliminate the tax. One common method is a revocable living trust, which can help avoid probate and may offer some tax planning benefits depending on how it is structured.
Gifts made during life can reduce an estate's size. The federal government allows a certain amount of gifts per year without tax consequences, and a larger lifetime gift amount before any gift tax applies. Gifts to spouses and to certain charities are not counted against these limits.
Charitable donations, either during life or through a will, reduce the estate's taxable value. Some people set up charitable trusts that provide income to family members during life and then give the remainder to charity, lowering the taxable estate while supporting causes they care about.
Irrevocable life insurance trusts, family limited partnerships, and may have access to personal residence trusts are other strategies used by people with very large estates. These are complex arrangements that require professional help to set up correctly.
Who needs to file an estate tax return
An executor must file a federal estate tax return if the estate is large enough. The threshold changes each year, so the executor needs to know what year the person died and what that year's threshold was.
Even if the estate is below the threshold and no tax is owed, some executors file a return anyway. Filing can be useful if the estate has complex assets, if there are questions about value, or if the executor wants a formal record that the return was filed and reviewed by the IRS.
State estate tax returns are filed separately in states that have an estate tax. The rules and deadlines vary by state. An executor in a state with an estate tax needs to understand both the state and federal requirements.
Frequently Asked Questions
Do heirs have to pay estate tax on what they inherit?
No. The estate pays the tax before assets are distributed to heirs. Heirs do not owe income tax on inherited money or property. However, if inherited assets later earn income — such as interest on a bank account or rent from rental property — that future income is taxable to the heir.
What happens if the executor does not file an estate tax return?
The IRS can assess penalties and interest. If the estate owes tax and the return is not filed, the debt grows. The executor has a legal duty to file if required. A tax professional can help determine whether filing is required in a specific situation.
Can you reduce estate tax by giving money to family members before you die?
Yes. Gifts during life reduce the size of your estate, which lowers the taxable amount at death. Federal law allows a certain amount of gifts per year without tax consequences. A tax professional can explain the current limits and help plan a gifting strategy.
Is estate tax the same in every state?
No. Most states do not have an estate tax at all. The twelve states and D.C. that do have their own rules, thresholds, and tax rates. If you own property in multiple states, you may need to understand the rules in each one.
What is the difference between estate tax and inheritance tax?
Estate tax is paid by the estate before distribution to heirs. Inheritance tax is paid by the people who inherit. Only a few states have inheritance tax. The rules, rates, and thresholds are different in each state that uses them.