State vs Federal Estate Taxes: What You Need to Know

Introduction: The Hidden Tax That Can Shrink Your Legacy

State-level taxes are often forgotten, especially since federal estate taxes have a high exemption threshold. You need to understand how both state and federal estate taxes work to properly protect your legacy and minimize your heirs’ tax burden.

In this guide, we will go over the differences between state and federal estate taxes, who they affect, and practical strategies to reduce the tax burden.

What Are Estate Taxes?

Estate taxes are taxes on the assets you transfer to your heirs after you pass away. They are meant to prevent large transfers of untaxed wealth. Most people do not need to worry about federal estate taxes since there is a high exemption threshold: if your estate doesn’t exceed that threshold (around $15 million), then you are exempt.

Difference from inheritance tax

Estate tax is paid by the estate before assets are distributed. On the other hand, inheritance tax is paid by individual heirs in a few states.

Whether you owe taxes on your estate (or if your heirs will owe any inheritance tax) depends on where you live and how large your estate is.

The Federal Estate Tax Explained

Federal exemption threshold

The federal exemption threshold is how much of your assets can be transferred to beneficiaries without being taxed through federal estate obligations. Estates that are higher than the amount specified by the IRS ($13.99 million per person in 2025) will not need to pay any federal estate taxes.

Tax rate

The tax rate can be anything from 18% to 40%. It depends on how much the estate exceeds the exemption. Graduated tax rates can make it more confusing if you aren’t sure how much you would need to be taxed, so a tax professional can help you properly identify estate tax rates and expectations.

Portability

Portability plays a large role in reducing the overall estate taxes for couples. A surviving spouse can use a deceased spouse’s unused lifetime estate and gift tax exemptions, which essentially means doubling the protection from federal estate taxes.

Important: this is not an automatic process. You have to file a special Form 706 in order to port over your deceased spouse’s remaining exemption. There is a five years due date for electing portability, and you may need to pay some fees when filing.

Assets included in taxable estate

Real estate, cash, investments, business interests, retirement accounts, and life insurance (if owned by the decedent) are common assets included in taxable estates.

Is the sunset clause still happening?

You may have heard of the sunset clause of the 2017 Tax Cuts and Jobs Act (TCJA). The TCJA was set to expire on December 31st, 2025, which would have made the exclusion amount drop to around $7 million. However, the One Big Beautiful Bill Act set a $15 million federal estate and gift tax exemption in 2026.

State Estate Taxes: The Rules Are Different Everywhere

Only a handful of states impose estate taxes, but thresholds are usually much lower than the federal level. Look at your state’s estate tax numbers to be sure whether you would need to pay. State tax laws can also change over the years so be sure you have the most up-to-date information.

Common state estate tax thresholds

Oregon & Massachusetts: Around $1 million

New York: $7 million+

Washington, DC: Around $4.8 million

Does federal state exemption mean you don’t owe state estate tax?

No. Even if your estate is exempt federally, you could still owe state-level estate tax.

Inheritance taxes

A few states (e.g., Iowa, Maryland, Nebraska, Pennsylvania, Kentucky) tax heirs directly, depending on their relationship to the deceased.

How State and Federal Estate Taxes Interact

The estate tax deduction is a way to prevent double taxation. The same assets shouldn’t be taxed twice by both state and federal taxes. However, a large estate might face double taxation on its federal estate taxes

State credit

Some states offer a credit or deduction for federal taxes paid.

Residency matters

The state where you reside (or where your assets are located) determines your estate tax exposure. If you owe property in multiple states, it will be more complex. These properties can trigger taxes in more than one jurisdiction, so be careful.

Example: If you live in Oregon and own a vacation home in California, your estate may owe Oregon estate tax and California property-related taxes depending on your asset worth and other factors.

Who’s Most at Risk

High-net-worth families

Families with sizable estates in the millions are most at risk for all kinds of taxation. State estate tax thresholds are lower, so if you have over $6 to $7 million in assets, you probably owe estate taxes.

Property-rich households

Rising home values push many estates above state thresholds, which can surprise families who don’t realize it. You may want to check the valuation of your properties.

Business owners and farmers

Estate taxes can force the sale of family businesses or land if there is not enough estate or succession planning in place.

Retirees relocating

Moving from a high-tax to a low-tax state can dramatically change your estate’s tax liability.

Strategies to Minimize Estate Taxes

Use Lifetime Gifting

Gifting is one of the best strategies for reducing estate tax obligations. Essentially, you can gift up to $18,000 per person per year (2024) tax-free. This helps reduce the size of your taxable estate.

Establish Trusts

You can transfer your assets into a trust (on top of having a will). Trusts can be either revocable (easily modified) or irrevocable.

Irrevocable Trusts: You remove the assets from your taxable estate, losing control over them. It is very difficult to modify the terms or take back the assets within an irrevocable trust, but these trusts have better asset protection and other benefits. Irrevocable trusts can help you reduce your taxable estate.

Bypass/AB Trusts: Help married couples maximize exemptions and reduce tax burdens.

Charitable Remainder Trusts (CRTs): Combine philanthropy with tax savings.

A trusted platform like LegalZoom can help you set up basic trust structures affordably.

Relocate to a State Without Estate or Inheritance Taxes

Some states are known for their low estate or inheritance taxes. Popular low-tax states include Florida, Texas, Nevada, and Arizona.

Leverage Life Insurance

You can use a special Irrevocable Life Insurance Trust (ILIT) to keep life insurance proceeds out of your taxable estate. This is highly recommended if you want to reduce the tax obligations that can negatively impact your loved ones.

If you don’t carry life insurance yet, Ethos offers affordable, easy-to-manage policies that integrate seamlessly with estate plans. Check out our guide on how life insurance fits into an estate plan.

Marital Transfers and Portability

Assets transferred to a surviving spouse are free from estate taxes. Look at your estate plan and asset transfers to see how you can maximize both you and your spouse’s federal exemptions.

Charitable Giving

Donating appreciated assets is another valuable way to reduce your estate size and income tax liability. Just make sure you are compliant with tax regulations. A tax professional can advise you on how to donate meaningfully while also avoiding tax issues.

How to Plan Ahead

It’s important to plan ahead so you and your family can avoid unnecessary taxation. Here are basic guidelines for general estate tax planning.

First, calculate your total estate value. Include real estate, investments, business holdings, and insurance. Digital assets and other unconventional assets should also be remembered.

Next, check your state’s laws. Thresholds can vary dramatically. If you exceed the threshold, you would end up needing to pay estate taxes. By being aware of this, it’s easier to implement strategies in advance that can reduce the estate tax obligations.

Now that you have a general idea of your situation, it’s time to contact a professional.

Work with professionals

Estate attorney: An estate attorney can help you navigate the complicated world of trusts and compliance.

Tax advisor: To navigate both state and federal requirements. Tax advisors can help you determine what tax obligations you and your heirs would have. Extremely useful for those with mid- to larger estates.

Online tools: Services like LegalZoom can help you start or update estate documents. They are far more affordable and accessible, so they are a great starting point.

Review your plan regularly

Always look at your estate plan and make the necessary updates after major life events or tax law changes. Here are trigger events that should make you check your estate plan, from asset distribution to beneficiary choices.

• New children
• Death in the family
• Divorce
• Changes in relationships
• Moving states or abroad

Common Mistakes to Avoid

Assuming federal exemption covers everything

It does not. Check what federal exemptions do not cover. Generally, the federal estate tax exemption only covers the gross estate, which includes everything owned at your death.

In addition, if you have any special assets like business interests or life insurance, these may have their own separate rules and tax circumstances.

Ignoring state estate or inheritance taxes

A lot of people forget about state taxes after filing their federal returns. The same happens for estate purposes. Be sure you’re aware of all state estate and inheritance taxes that may impact your taxation.

Forgetting to adjust your plan after moving states

Moving can impact your estate plan and tax situation. Every state has its own estate tax laws and other rules that may impact your estate plan unexpectedly. Always review and update your estate plan as needed if you move states.

Forgetting about life insurance proceeds

Life insurance proceeds generally do not count as taxable income. However, check your situation to see if you need to put your life insurance into a trust. Having life insurance proceeds go directly to somebody may impact their eligibility for certain government benefits.

Not coordinating with a tax professional for compliance

A tax professional for estate planning purposes can save you and your loved ones a lot of hassle and tax burden. Ensure that you are complying with tax laws by consulting with a tax expert.

Failing to properly pay estate taxes, either federal or state, can lead to significant penalties. The executor would not be able to distribute assets as intended until the debts and extra charges are settled, which can take a long time and be very confusing.

The Future of Estate Taxes: Why You Should Act Now

Taxes are a complex, if controversial, topic. Many middle- to upper-income families wonder how much new taxes they may be exposed to since tax regulations can change at any moment.

It is crucial to review and update your estate plan before the law changes against your favor. If it changes to benefit you later on, you can make changes as well.

One Estate, Two Tax Systems: Plan for Both

Estate taxes can differ dramatically between federal and state levels. While double taxation isn’t usually a concern, ignoring either tax can cost your heirs a significant amount of money.

Early planning, smart gifting, and well-structured trusts can help you keep more of your legacy where it belongs: with your loved ones.