Inheritance Tax Planning: Rules and Exemptions

An inheritance can add to your finances, but taxes may reduce the amount that reaches you. Some states tax beneficiaries directly, while separate estate taxes may apply before assets are distributed. Inheritance tax planning accounts for these rules in advance by using exemptions and transfer strategies to limit what is lost to taxes.

A financial advisor with estate and tax planning experience can help you review your situation and plan asset transfers in a tax-efficient way.

What Is Inheritance Tax Planning?

Inheritance tax planning focuses on preparing for taxes that may apply when someone receives assets after a death. The goal is to reduce surprises for heirs and avoid situations where beneficiaries need to sell assets quickly to cover tax bills.

There is no federal inheritance tax in the United States, but a small number of states impose one. Kentucky, Maryland, Nebraska, New Jersey and Pennsylvania currently have inheritance taxes. The rules vary by state, and the amount owed often depends on who is receiving the inheritance.

In most of these states, spouses do not pay inheritance tax. Some states also offer partial or full exemptions to close relatives such as children or parents. More distant relatives, friends or unrelated beneficiaries often face higher tax rates and lower exemptions, which can reduce what they ultimately receive.

Inheritance tax planning helps families account for these differences in advance. By reviewing who will inherit which assets, how accounts are titled and which exemptions apply, families can structure transfers in a way that limits taxes and preserves more of the estate for beneficiaries.

Inheritance Taxes vs. Estate Taxes

Inheritance taxes and estate taxes are often grouped together, but they apply at different points in the transfer of assets.

Estate taxes apply to the total value of an estate before assets are distributed. The tax is paid by the estate itself, which reduces the amount available to beneficiaries. Federal estate tax applies only when the estate exceeds the federal exemption, and some states impose their own estate taxes with lower thresholds.

Inheritance taxes apply after assets are transferred and are paid by the beneficiary, not the estate. The tax is based on the value of what each person receives. States that impose an inheritance tax often apply different rates depending on the beneficiary’s relationship to the deceased.

With estate taxes, beneficiaries receive what remains after the tax is settled. With inheritance taxes, beneficiaries receive assets first and then pay the tax directly. This difference affects both the timing of the tax and who is responsible for covering it.

Because the two taxes apply at different points, an estate can face one, both, or neither depending on its size, location and beneficiary structure. Planning addresses these rules separately to limit how much value is lost before and after assets change hands.

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How Inheritance and Estate Taxes Work

There is no federal inheritance tax, but estates above the exemption may owe federal estate tax.

As we mentioned above, there is no inheritance tax at the federal level, but estates exceeding a certain value may owe federal estate tax. For 2026, the federal estate tax exemption is $15 million per person (or $30 million for married couples). Estates below this threshold owe no federal estate tax, but larger estates may face rates as high as 40% on the amount above the exemption.

State inheritance taxes work differently. They depend on:

Where the decedent lived: Only states that impose inheritance taxes apply them.
The heir’s relationship: Immediate family members often qualify for partial or full exemptions, while non-relatives usually pay more.
The inheritance amount: Larger inheritances are taxed progressively, with higher amounts facing higher rates.

For example, if you inherit $500,000 from an aunt in Pennsylvania, you would likely owe a 15% inheritance tax. However, if the same inheritance came from a spouse, you’d likely be exempt.

Because rules vary, inheritance tax planning ensures you understand both federal and state thresholds and how they apply to your assets.

Key Exemptions and Deductions to Know

Knowing which transfers and assets qualify can dramatically reduce or eliminate your tax exposure. Here are some of the exemptions it helps to be aware of:

Spousal exemption: Assets transferred to a surviving spouse are typically exempt from both estate and inheritance taxes.
Parent-child exemption: Many states exempt direct transfers between parents and children, or tax them at lower rates.
Charitable donations: Bequests to qualified charities are generally excluded from both estate and inheritance tax calculations.
Small estate exemptions: Some states waive inheritance tax for estates under a certain value, often ranging from $25,000 to $100,000.

Strategies for Reducing Inheritance and Estate Taxes

Smart inheritance tax planning doesn’t happen after someone passes, it starts while they’re still alive. Proactive strategies can lower taxable estate values and reduce future tax burdens for beneficiaries. The following are some of the strategies that can be used to help potentially minimize inheritance and estate taxes:

Gifting during life: Under the annual gift tax exclusion, you can give up to$19,000 per person (2025) without triggering gift tax or affecting your lifetime exemption. Spreading gifts over several years can transfer substantial wealth tax-free.
Irrevocable trusts: Placing assets in an irrevocable trust removes them from your taxable estate while still allowing control over how and when beneficiaries receive them. Common options include bypass trusts, qualified personal residence trusts and irrevocable life insurance trusts (ILITs).
Charitable trusts: Charitable remainder or lead trusts let you support a cause while securing tax deductions and reducing estate value. These structures can also provide lifetime income for you or your heirs.
Family limited partnerships (FLPs): Families that own businesses or real estate can consolidate ownership under a Family Limited Partnership (FLP), then gift limited partnership interests to heirs at discounted values. This can significantly reduce estate size for tax purposes.
Life insurance strategies: Life insurance proceeds are generally not taxable income, but they can increase estate size. Placing policies in an irrevocable life insurance trust (ILIT) can help cover estate taxes without adding to the taxable estate.

Common Mistakes to Avoid in Inheritance Tax Planning

Even well-intentioned estate plans can fall short if they miss key tax details. Common issues include the following:

Procrastinating: Delaying planning can limit available tax strategies, especially as asset values change or tax rules are updated.
Failing to update documents: Life events such as marriage, divorce, births or new assets can change how exemptions and beneficiaries apply.
Ignoring state rules: Focusing only on federal law can lead to missed state-level inheritance or estate tax exposure.
Overlooking non-probate assets: Life insurance, retirement accounts and jointly owned assets can still affect the size of a taxable estate.
Not reviewing beneficiary designations: Bank accounts and retirement accounts with payable-on-death (POD) or transfer-on-death (TOD) designations pass directly to beneficiaries but can still carry tax implications if not coordinated with the broader plan.
Not consulting professionals: Tax rules change and vary by jurisdiction, and without professional input, planning gaps can remain.

Working With a Financial Advisor or Estate Planner

Inheritance tax planning involves multiple areas, including investments, taxes and legal structure. A financial advisor or estate planner can help review how your assets are titled, who is named as a beneficiary and how different transfers may be taxed. This coordination can reduce gaps that occur when financial and legal decisions are handled separately.

A financial advisor can run projections that show how estate values may change over time and how different tax rules could apply. Working alongside an estate attorney, the advisor can help put strategies in place, such as trusts, lifetime gifts or insurance arrangements, that fit within current tax rules and the terms of your estate documents.

Advisors can also coordinate estate planning with retirement and investment decisions. Managing the mix of pre-tax and post-tax accounts, along with beneficiary designations, affects both taxes during your lifetime and the tax treatment of assets passed to heirs.

Bottom Line

Coordinating estate, retirement and investment decisions affects both lifetime taxes and what heirs receive.

Inheritance tax planning focuses on how assets transfer to beneficiaries and how taxes can reduce what they receive. Because estate and inheritance taxes follow different rules and vary by state, planning involves reviewing asset values, beneficiaries and applicable exemptions. This process helps limit tax exposure and preserve more of the estate for heirs.

Estate Planning Tips

A financial advisor can help you review inheritance tax rules and exemptions as they apply to your assets and beneficiaries. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
While it may be tempting to save some money and plan your estate by yourself, you should still be careful with these DIY estate planning pitfalls.