How To Avoid Estate And Inheritance Taxes

Let’s talk estate and inheritance taxes.  First we’ll do definitions, and Investopedia is great for those. 

What is an estate tax?

An estate tax is a levy on estates whose value exceeds an exclusion limit set by law. Only the amount that exceeds that minimum threshold is subject to tax. Assessed by the federal government and a number of state governments, these levies are calculated based on the estate’s fair market value (FMV) rather than what the deceased originally paid for its assets. The tax is levied by the state in which the deceased person was living at the time of their death. 

It seems (to me at least) a bit cruel to have to pay a tax for your estate simply because you die, but this is indeed the case in certain circumstances. 

What is an inheritance tax?

An inheritance tax is a tax imposed by some states on the recipients of inherited assets. In contrast to an estate tax, an inheritance tax is paid by the recipient of a bequest rather than the estate of the deceased. 

Notice they didn’t mention any federal component here, inheritance taxes only exist in some states.  An easy way to think of this is if your parent dies and leaves you money, an inheritance tax could tax that money in some circumstances.

Both of these may leave a sour taste in your mouth, so let’s get to the meat of the matter and see who might be at risk to pay these taxes.

 

Who Pays

I like maps and I cannot lie, you other mappers can’t deny.  Even though it would be pretty easy to list the states that have estate and inheritance taxes as there aren’t too many, a map is better and more fun.  So the folks at Tax Foundation have us covered. (click for a larger version)

Estate And Inheritance Taxes

 

As you can see twelve states and the District of Columbia currently have an estate tax.  The Tax Foundation article explains that most states have been moving away from estate taxes after the federal government phased out the state estate tax credit it first implemented in 1926. 

States that do still have an estate tax have been generally raising the exemption amount, with the exception of the District of Columbia.  Washington D.C. recently lowered it’s exemption amount from $5.8 million to $4 million. 

There are quite a few members of the FIRE community I know that would have to pay an estate tax on their assets if they had the misfortune of dying while being a resident of Washington D.C.

 

Inheritance Tax

As you can see on the map there are currently only six states that have an inheritance tax.  And Maryland holds the distinction of being the only state with both an estate tax and an inheritance tax. 

As someone who was born and raised in Baltimore and lived in Maryland until I was about 30, I can confirm that Maryland is a very high tax state all around.  In the D.C. region many of us jokingly call it the “People’s Republic of Maryland”.  When I left Maryland I had a lot more money in my pocket, everything seems to be taxed high there. 

Nebraska has the highest rate of the six states with an inheritance tax that tops out at a whopping $18%.  That doesn’t mean everything is taxed at 18% for anyone who inherits it, it’s complicated of course.  Because that’s what bureaucrats do. 

The Platte Institute explains Nebraska’s inheritance tax:

In short, if a resident of Nebraska dies and their property goes to their spouse, no inheritance tax is due. If it goes to their parents, grandparents, siblings, children, or a lineal decedent (or their spouse) then the tax is applied to anything over $40,000 at a rate of 1%.  If it goes to an aunt, uncle, niece, nephew, or any lineal decedent of these people (or their spouse) then the tax applies to any property over $15,000 at a rate of 13%. For anyone else, the tax is applied to all property of more than $10,000 at a rate of 18%. 

Ouch.  $10,000 isn’t a huge sum of money in the grand scheme of things.

 

Run Away

So how do you avoid estate and inheritance taxes?  Don’t live (or die) in a state that has them!  Ha, now you’re angry over my click-baity title, but darn if it ain’t true.  Of course avoiding the federal estate tax is harder. 

The federal estate tax doesn’t kick in until someone dies with $12.06 million in assets or more.  So most folks don’t have to worry about it, but devotees of the FIRE movement shoot for the stars, so we’re a bit different. 

NerdWallet does a great breakdown of the federal estate tax rules and nuances, it’s worth a read. 

If you do expect to die with more than $12 million, your options to avoid this tax are limited.  Besides spending or giving away your money, an irrevocable trust is one method to legally avoid paying this tax. 

That’s it financial warriors, now you know how to avoid paying estate and inheritance taxes. 

Your Turn – I’ll throw a fun question out this time: Do you expect to die with more than $12 million in assets?

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Dave @ Accidental FIRE

I reached financial independence and semi-retired in my mid-40's through hard work, smart living, and investing. This blog chronicles my journey and explores many aspects of personal finance including the psychological and behavioral factors that drive our habits.

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12 Responses

  1. i like the article for anyone who cares about leaving money to their offspring. i think we’ll be ok with not hitting $!2m as i intend to trim quite a bit as investments go up and either enjoy the money of give it away while living. i was just talking the other day about how at age 54 the next 10 years are probably much more valuable to me versus the 10 from 64 to 74 and it just goes down from there. we intend to enjoy a bunch now.

    • Dave @ Accidental FIRE says:

      My thinking is the same, if I only have 30 or 40 years left on this blue planet well then the next 10 are gonna be the ones where I’m the healthiest and most able to do shit. I value them the most. It’s a pragmatic decision

  2. Trish says:

    100% agree with Freddy. I am saving $$ to enjoy life today and purchase my freedom, not to leave behind.

  3. Steve says:

    “There are quite a few members of the FIRE community I know that would have to pay an estate tax on their assets if they had the misfortune of dying while being a resident of Washington D.C.”

    To be more precise (and I know you like precision), the dead person does not pay the estate tax.

  4. Jim says:

    It’s interesting to see that all the states in Pink are typically controlled by 1 party. And, these states have higher levels of crime, homelessness, taxes, and sanctuary policies. Coincidence? Nah! I’m just grateful I dont live in one of them!

    • Steve says:

      Many of the “Pink” states do have higher tax rates, but most have lower than average property crime and violent crime rates. Did you mistype?

      • Dave @ Accidental FIRE says:

        Alright folks, I don’t allow overtly political commenting on my blog and it’s drifting in that direction. I sincerely appreciate your reading and commenting but let’s keep it on topic and non-political. This post isn’t about violence or crime or political parties, it’s just showing states with inheritance and estate taxes. Thanks for your cooperation and for reading!

  5. Joe says:

    Yet another reason to leave Oregon. California, here we come! Well, in 7 years or so when our son is done with school.

    • Dave @ Accidental FIRE says:

      I’m sure you’ve done you research but just be careful of all of California’s taxes and regulations, they have many!

  6. Mr. Tako says:

    Thankfully we just moved to a state without an inheritance tax or an estate tax! It was always a concern in the back of my mind, but it’s one of those things most people don’t worry about until they’re old.

    Unfortunately age creeps up on all of us, and it typically gets harder to move as you get older. I’m glad we moved before our lifestyle got cemented into place!

    • Dave @ Accidental FIRE says:

      I think you picked well, Arizona is lovely and seems to be relatively lower tax overall. Sounds like you’re settled for good and that must be a great feeling!

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