When someone dies, their property transfers to their estate to pass through probate and be distributed according to the decedent’s will. Estates are responsible for paying final taxes before divvying up the property to heirs. The federal government imposes a tax on high net-worth estates, but it does not tax inheritance passed on to heirs. States can set their own laws regarding estate and inheritance taxes.
Although estate taxes can't be deducted, the IRS allows up to a certain amount of tax-free estate gifts per taxpayer.
Deducting Paid Estate Taxes
The IRS allows individuals to gift up to a certain amount over a lifetime without incurring taxes. The value of a person’s taxable estate depends on the fair market value of the property the person has a right to transfer at the date of his death. The total value of all transferrable property forms the gross estate, from which the person responsible for administering the estate must make certain adjustments to arrive at the taxable estate. After subtracting deductions, such as administrative expenses and property passed to spouses and qualified charities, the value of gifts made over the taxpayer’s lifetime is added back to arrive at the taxable estate.
Estate planning seeks to reduce the amount of estate and inheritance taxes due to carry out the taxpayer’s will. While a taxpayer who donated his entire estate to charity would not owe any estate taxes, nor would his heirs owe any inheritance taxes, his heirs would have no inheritance. Estate taxes can be reduced by splitting the estate between both spouses to maximize the exemption amount.
Exceptions for Nebraska Estate Tax Laws and Other States
In addition to a taxpayer's federal obligations, six states impose an inheritance tax of their own. Kentucky and New Jersey tax estates at 16 percent, while Maryland's is only 10 percent. In between those ranges are Massachusetts, Rhode Island, Connecticut and Delaware. Survivors don’t receive their inheritance until the estate is settled, a process that includes paying estate taxes. Until a survivor receives her inheritance, she doesn’t owe and cannot pay any inheritance tax. Estates cannot deduct paid inheritance tax because inheritance taxes are incurred after the estate is settled.
While the federal government provides a generous exemption amount, increasing the number of estates that fail to incur any estate taxes, 14 states and the District of Columbia levy their own death taxes. State-level estate taxes often have far lower exemptions, many around $1 million, which can include a much larger number of estates. State taxes can change more readily than federal taxes, and some tax experts anticipate more states might levy their own estate taxes in response to changes in how federal estate tax funds are distributed.
2018 Tax Change and Inheritance Taxes
The new tax laws bring good news for estates. The lifetime inheritance limit has been increased to $11.18 million, which means $11.18 million in value can be transferred to heirs without taxes.
2017 Taxes and Estate Taxes
In 2017, the estate tax limit was only $5.49 million. If the estate's worth exceeded this amount, you'll need to use Form 1041 Schedule G. If your state has an additional estate tax, you'll need to track down the appropriate paperwork for that, as well, such as the Nebraska Inheritance Tax Form.
- Internal Revenue Service: Estate Tax
- Putnam: Ten Income and Estate Tax Planning Strategies for 2013
- Tax Foundation: Does Your State Have an Estate or Inheritance Tax?
- Investopedia: A Quick Guide to High-Net-Worth Estate Plan
- IRS: What's New - Estate and Gift Tax
- IRS: About Form 1041, U.S. Income Tax Return for Estates and Trusts
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