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Estate Tax vs. Inheritance Tax - What you Need to Know

When it comes estate tax vs inheritance tax, what are the main differences? Who pays? And how much? Trust & Will explains what you need to know.

Estate tax and inheritance tax are related, and the terms are often used interchangeably. Although it can be easy to get the two mixed up, they are not the same. If you’re expecting to receive an inheritance any time soon, or you’re preparing your estate plan, then it’s best to be informed on how you might be affected. In this guide, we’ll explain the difference between estate tax vs. inheritance tax, and when you might become liable for each. That way, you can have peace of mind knowing you won’t get any unpleasant surprises. 

What is Estate Tax?

Estate tax is a type of tax that’s assessed on an estate. The purpose of the tax is to ensure the proper management and transfer of an estate, from the decedent to the beneficiary.

How Estate Tax Works

The estate tax is calculated using the net value of the estate. This means that any outstanding liabilities are subtracted from the estate’s value to calculate the taxable amount. It should be pointed out that the date of the decedent’s death is used to evaluate the estate’s net value.

Everyone is subject to estate taxes at the federal level, but you should find out if you are in one of the states that also assesses this tax. The estate’s executor is responsible for paying taxes out of the estate, so the inheritance you receive is the reduced amount after the fact. Find out everything you need to know in our estate tax guide.

What is Inheritance Tax?

If you received an inheritance, then you may be subject to inheritance tax. If you’re subject to it, then you should know that it’s calculated using the value of the assets you inherited. In some cases, the Will may provide that the inheritance tax is to be paid for by the estate. 

How Inheritance Tax Works

Luckily, the Internal Revenue Service (IRS) doesn’t view inheritance as income, so you only really need to worry about inheritance tax at the state level.

There are currently six states that impose an inheritance tax, and even then, they offer certain exemptions. Each of the states also exclude you from the tax if you’re a surviving spouse, and some exclude surviving children and grandchildren. 

One thing to note is that it doesn’t matter where you live. What matters is the state in which the inherited asset was purchased. For example, if you live in one of the six states that collects income tax, but you inherited a house that isn’t located in one of these six states, then you won’t be subject to the tax. Be sure to read our inheritance tax guide to find out which of the six states impose this tax, along with other helpful tips and information.

Estate Tax vs Inheritance Tax - 3 Key Differences

Now that we’ve explained how inheritance and estate taxes are imposed, it’s time to understand how to differentiate between estate tax vs. inheritance tax. Keep reading to find out the three key differences; it’ll help avoid any confusion their similarities can cause you.

1. Where the taxes are paid (at the state level or the federal government level)

For any tax, find out if it’s paid at the state or federal level. Sometimes it can be both. Inheritance tax is only paid at the state level.  On the other hand, estate tax is paid at both the federal and state levels. 

2. Who’s responsible for the tax

A second key differentiation between estate and inheritance tax is who is responsible for paying the tax. If you are the one receiving the inheritance, then you’re responsible for paying any inheritance tax. However, the estate itself is responsible for paying estate tax before the inheritance is distributed. You might be wondering how that’s possible. The decedent appoints an Executor in their Will. This individual is responsible for making sure the tax is paid, on behalf of the estate.

3. Not all states are subject to inheritance tax

Not all states are subject to the inheritance tax. More specifically there are only 6 states that impose the tax. 

What States Have Inheritance Tax?

You’re probably at the edge of the seat wondering whether you live in one of the six states that assess an inheritance tax. Luckily, the odds are stacked in your favor.

Here are the six states that collect inheritance tax:

  • Iowa

  • Kentucky

  • Maryland

  • Nebraska

  • New Jersey

  • Pennsylvania

In Conclusion: Estate Tax vs Inheritance Tax

Estate and inheritance taxes are easy to mix up, but they are not at all the same. There are three key ways to identify the differences between them: if the taxes are paid at the federal or state level, who is responsible for paying the tax, and which states impose either tax. 

The fact that you’re reading up on the difference between estate tax vs. inheritance tax is a great sign. It means that you’re preparing in advance of receiving an inheritance, and you want to understand the differences between any taxes you might be subject to. Or perhaps you’re on the other end, and you’re someone who is setting up a Trust or Will. Knowing these key tax impacts and differences is the first step to maximizing the benefit you can bestow upon a loved one. With the right estate planning tools and strategies, you can do exactly that. 

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