Inheritance tax is one of those topics that sits quietly in the background of estate planning, until it suddenly matters. And when it does, the rules can feel confusing, emotional, and frustrating, especially if you’re already dealing with loss.
This guide breaks it all down in a practical and easy-to-understand way, what inheritance tax is, who actually pays it, and when you need to care.
What Is Inheritance Tax?
Inheritance tax is a state-level tax that some beneficiaries pay when they receive assets from someone who has died. That’s the key distinction right there: The person receiving the inheritance pays the tax. It can apply to things, like cash, real estate, investment accounts, and personal property.
Inheritance Tax vs. Estate Tax (They Aren’t the Same)
| Estate tax | Inheritance tax |
|---|---|
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Here’s a simple way to think: Estate tax looks at the size of the pie. Inheritance tax looks at who gets which slice.
Is There a Federal Inheritance Tax?
There’s no federal inheritance tax, and there hasn’t been one for more than a century. The IRS doesn’t tax inheritances simply because you received them. If you ever hear about an inheritance tax, it’s coming from state law, not the federal government.
Which States Still Charge Inheritance Tax?
As of 2024–2025, only five U.S. states impose an inheritance tax: Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. Iowa officially phased out its inheritance tax on January 1, 2025.
| States | How they work |
|---|---|
| Kentucky | Kentucky uses a tiered system based on relationship:
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| Maryland | Maryland is unique because it also has a separate estate tax, which can affect larger estates.It has a flat inheritance tax rate:
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| Nebraska | Nebraska’s rates depend on both relationship and amount inherited:
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| New Jersey | New Jersey eliminated its estate tax but still has inheritance tax:
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| Pennsylvania | Pennsylvania applies different rates by relationship:
Pennsylvania offers small discounts for early payment in some cases. |
Do You Pay Inheritance Tax on Cash?
Usually, the answer is “no,” at least not directly. If you inherit cash, the inheritance itself is generally not considered taxable income, and you don’t have to report it simply because you received it.
However, any interest or investment income the inherited money earns after you receive it may be taxable. In addition, inheritance tax can still apply depending on the state you live in and your relationship to the person who passed away.
What About Capital Gains on Inherited Assets?
This is where many people get tripped up. When you inherit assets like stocks or real estate, they usually receive a step-up in basis to their value on the date of death. In practical terms, that means you’re typically taxed only on gains that occur after you inherit the asset, not on the appreciation that happened during the original owner’s lifetime. If you sell soon after inheriting, there’s often little or no capital gains tax at all. Inheritance tax and capital gains tax are separate issues, but they tend to show up in the same conversation, often causing unnecessary confusion.
How to Reduce or Avoid Inheritance Tax
For most families, inheritance tax never applies. But if it might, you can consider these common strategies:
Gifting During Life
It’s often treated more favorably than inheritances, as many states don’t tax gifts the same way. At the federal level, annual gift tax exclusions allow you to transfer a certain amount each year without triggering gift tax. However, it’s important to be careful, some states have lookback or clawback rules that can affect eligibility for taxes or benefits later.
Trust Planning
It can help reduce inheritance tax exposure, as irrevocable trusts may remove assets from your taxable estate. This strategy is often used when beneficiaries are non-immediate family members or when more control over how assets are distributed is needed.
Life Insurance
Life insurance proceeds are often exempt from inheritance tax and can be a useful planning tool to equalize or replace taxable inheritances, helping beneficiaries receive value without increasing their tax burden.
State Residency Planning
It matters because where someone lives (and owns property) can significantly affect state-level taxes. Some families choose to relocate later in life to reduce or avoid these taxes, which is where a knowledgeable estate attorney or tax professional can provide valuable guidance.
Why Most People Never Pay Inheritance Tax
Here’s the reality check. Only five states still impose an inheritance tax, and most immediate family members are fully exempt. Even in states where the tax exists, exemption thresholds are often generous, which means fewer than 2–3% of inheritances are actually taxed. Inheritance tax gets a lot of attention because it sounds intimidating, not because it’s a common or widespread problem for most families.
The Bottom Line
Inheritance tax isn’t something most Americans will ever pay, but if it applies to you, it can feel confusing and unfair without context. Don’t worry, only by reading this article carefully and remembering several key takeaways, you can deal with it easily.
