Strategies for How to Avoid Inheritance Taxes

When a loved one dies, there are a lot of things to worry about, from planning the funeral to dealing with your oWhen a loved one dies, there are a lot of things to worry about, from planning the funeral to dealing with your own emotions. And often, money is a major part of the calculus of life. When a person passes, their family will have to deal with their money, assets and debts. And if they have a large enough estate, they’ll potentially have to worry about estate and inheritance taxes. There are things you can do now, though, that will limit the amount of money ultimately subject to these taxes. That way, more of your wealth will go to your family, as opposed to the government.

For help with the estate tax or any other financial planning issues, consider working with a financial advisor.

Understanding the Differences Between Estate Taxes & Inheritance Taxes

First thing’s first: Make sure you know the difference between the estate tax and the inheritance tax. The estate tax, sometimes called the “death tax,” is money taken by the government from the estate of a recently deceased person before it’s passed on to their family, friends and other beneficiaries. There is a federal estate tax, and a number of states also levy their own estate tax.

The inheritance tax, meanwhile, is levied on money after it has passed on to an heir. Money can be subject to both inheritance and estate taxes. There is no federal inheritance tax, but a number of states levy inheritance taxes.

The rules for these inheritance taxes vary from state to state. Sometimes the inheritance tax only applies based on the state the heir lives in, though it can also matter what state the person who died was living in. Even what state the property, like a house you inherit, is incan affect the situation.

Inheritance Tax Avoidance Strategies

If you think you’ll be getting an inheritance when a loved one dies, the first thing you should do is check the laws in both the state you live in and the state they live in. If neither of the states levy an inheritance tax, you’re in the clear. While there may be an estate tax to deal with, you won’t pay inheritance tax on any money you actually receive.

If there is an inheritance tax to consider, though, there are some things you can do to decrease your tax burden. Keep in mind that some of these steps will require advance planning and cooperation with the person leaving you the inheritance. So, if you believe you’ll be getting an inheritance, think ahead and talk with your family member about the most efficient way to transfer money.

Arrange to Receive the Money as Gifts

If you’re going to be getting an inheritance from a relative who is getting older, consider talking to them about getting some of it as gifts before they die. Currently, the annual gift tax limit is $15,000, so a person can give up to $15,000 to a person each year with no tax implications.

Let’s say your grandmother has told you she’ll be leaving you $45,000 in her will. If, instead of willing you this money, she gave you $15,000 a year for three years before she passed, the money would not be subject to inheritance tax. Plus, you could invest it in stocks or index funds and end up with more money by the time she actually passes away. If it makes your relative feel better, you could even promise not to touch the money until they’re gone.

Use an Alternate Valuation Date

Not all inheritances are cash, as many people receive property, including homes and other real estate. Generally, the property value used for inheritance tax purposes is the value on the date of death. If the estate is also subject to the estate tax, though, using a later date, generally six months after death, may be an option. This could result in a lower property value and thus, a smaller tax burden.

Buy a Payable on Death (POD) Life Insurance Policy

If you set up a payable on death life insurance policy, your beneficiaries won’t owe any taxes on the money they receive upon your death. They can then use this money to pay any other inheritance or estate taxes that are levied.

Again, though, this will require some planning ahead of time.

Change Your Residence

This may seem like a drastic step, but for some people, it may make sense. Remember, not all states levy an inheritance tax, and there is no federal inheritance tax. If you’re at a place in your life where you can move, setting up shop in a state where there’s no inheritance tax could end up saving you or your beneficiaries a pretty penny.

Click Your State to Get Matched With Financial Advisors That Serve Your Area

Choose your state and answer some questions to get matched with up to three fiduciary advisors that serve your area.

Which States Have Inheritance Taxes?

A couple discuss how to avoid inheritance taxes with their advisor.

Inheritance taxes are not widespread in the United States, and the federal government does not assess this type of tax. Only a limited number of states maintain their own inheritance tax systems, which place the obligation on the recipient of the inheritance rather than on the estate itself. Currently, this includes Kentucky, Maryland, Nebraska, New Jersey and Pennsylvania.

Each state that applies an inheritance tax sets its own structure, including which heirs are subject to the tax and how much they may owe. Because state tax laws change, checking current rules in the relevant jurisdiction is necessary.

An heir’s relationship to the person who died often determines whether any inheritance tax applies. Close relatives such as spouses are frequently exempt. Children and other direct descendants may also qualify for reduced rates or full exemptions, while more distant relatives and non-family beneficiaries are more likely to face taxation.

Rates and exemption amounts vary by state. Some states use tiered rate schedules based on the size of the inheritance, while others apply different rates depending on the heir’s classification. Smaller inheritances may fall below exemption thresholds and result in no tax owed.

In most cases, the decedent’s state of residence governs inheritance tax treatment, though property located in another state can introduce additional complexity. Identifying which state rules apply is a practical first step before exploring ways to limit potential taxes.

Bottom Line

Inheritance tax is levied on money after it has been transferred to an heir. Most states do not have an inheritance tax, and there is no federal inheritance tax. That said, even if you live in a state where there is an inheritance tax, there are several steps you can take to minimize the amount of your inheritance that ends up being taken by the state.

While estate planning can lead to some difficult conversations, it will ultimately leave your family in a much better position after you pass. In fact, inheritance tax planning can be just as important as writing a will or setting up a trust.

Estate Planning Tips

If you or a loved one needs help reducing estate or inheritance tax burdens, consider working with a financial advisor. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
If you’re going at estate and retirement planning by yourself, it’s a good idea to prepare fully. SmartAsset has you covered with lots of free online resources that can help you plan for the future. For example, check out our retirement calculator.