Original article written by legacy firm, KDP Advisors (2022)
Learn the differences between state estate and inheritance taxes, which states impose them, and how to reduce their impact on your wealth. Expert tips inside.
When it comes to preserving wealth for your loved ones, estate and inheritance taxes can often create significant financial challenges. While many are familiar with the federal estate tax, fewer know about the state-level taxes that might impact your assets. These taxes vary by state, and understanding their implications is crucial for effective estate planning.
This blog will walk you through key differences between estate and inheritance taxes, highlight which states impose them, and provide actionable strategies to minimize their impact.
What Are Estate and Inheritance Taxes?
Estate Taxes
Estate taxes are levied on the total net value of a deceased individual’s estate before the assets are distributed to their heirs. Many states set an exemption amount, meaning only the portion of the estate that exceeds this threshold is subject to taxation. Tax rates typically vary by state and increase progressively based on the estate’s value.
Inheritance Taxes
Inheritance taxes, on the other hand, are imposed on individuals who inherit assets. Unlike estate taxes, the tax liability falls on the recipient rather than the estate itself. The rate often depends on the heir’s relationship to the deceased; close relatives like spouses are typically exempt, while distant relatives or unrelated beneficiaries may face higher rates.
Key Differences
- Who pays:
- The estate pays estate taxes before distributing the assets to the heirs.
- The heir pays inheritance taxes after receiving the assets.
- State laws:
- Estate taxes depend on the state where the deceased resided.
- Inheritance taxes depend on the state where the heir lives or where the property is located.
Understanding these distinctions is critical when determining how these taxes may affect your financial legacy.
Which States Impose Estate or Inheritance Taxes?
Not all states levy estate or inheritance taxes, and some impose only one of the two. Maryland stands out as the only state with both estate and inheritance taxes, making it especially important for residents or property owners there to plan strategically.
The table below provides a summary of states and their tax rates:
| State | Inheritance Tax | Estate Tax |
|---|---|---|
| Connecticut | None | Up to 12% |
| Hawaii | None | Up to 20% |
| Illinois | None | Up to 16% |
| Iowa | Up to 15% | None |
| Kentucky | Up to 16% | None |
| Maine | None | Up to 12% |
| Maryland | 10% | Up to 16% |
| Massachusetts | None | Up to 16% |
| Minnesota | None | Up to 16% |
| Nebraska | Up to 18% | None |
| New Jersey | Up to 16% | None |
| New York | None | Up to 16% |
| Oregon | None | Up to 16% |
| Pennsylvania | Up to 15% | None |
| Rhode Island | None | Up to 16% |
| Vermont | None | 16% |
| Washington | None | Up to 20% |
| Washington, D.C. | None | Up to 16% |
Spouses are generally exempt from both estate and inheritance taxes. If you reside in or have heirs in these states, it’s crucial to factor these taxes into your estate planning strategy.
How to Minimize Estate and Inheritance Taxes
While these taxes can significantly impact wealth transfer, several strategies are available to help reduce or even eliminate the burden. Below are some commonly used approaches:
1. Relocate to a Tax-Free State
States like Texas, Florida, and Arizona do not impose either estate or inheritance taxes. Moving to one of these states can help you avoid state-level taxes entirely, though federal estate taxes may still apply.
2. Use the Annual Gift Tax Exclusion
Reduce the taxable value of your estate by making tax-free gifts:
- Individuals can gift up to $16,000 per year to any number of recipients without incurring federal tax liability.
- Married couples can double this amount, gifting up to $32,000 per recipient annually.
3. Establish Trusts
Trusts are a powerful tool for reducing taxable assets and ensuring a smooth transfer of wealth. Consider the following options:
- Revocable Living Trusts protect your assets during your lifetime and streamline distribution after your passing.
- Irrevocable Trusts can remove assets from your taxable estate, making them exempt from estate taxes.
- Charitable Trusts allow you to leave a legacy by donating to a cause while gaining tax benefits.
4. Invest in Life Insurance
Proceeds from life insurance policies are typically exempt from estate and inheritance taxes. A properly structured policy ensures financial support for your heirs without additional tax liabilities.
5. Leverage Professional Guidance
State tax codes are complex and constantly evolving. Working with a professional estate planner or tax advisor can help tailor strategies to your unique situation, ensuring compliance while maximizing the wealth you pass on to loved ones.
Why Estate Planning Matters More Than Ever
Understanding and planning for estate and inheritance taxes isn’t just about preserving your wealth; it’s about protecting your family and ensuring your wishes are honored. Today’s financial landscape presents both challenges and opportunities, so taking proactive steps now will save your heirs significant stress in the future.
Still have questions about minimizing inheritance and estate taxes? Our team of experienced advisors is here to help. Contact us today to create a personalized wealth preservation plan that fits your needs.
Original article written by legacy firm, KDP Advisors (2022)
