Inheritance: tax considerations and tax-friendly approaches

The phrase “inheritance tax” gets used loosely to cover several genuinely different things — a federal estate tax that affects very few estates, a handful of state-level inheritance taxes that work completely differently, and a set of rules for inherited retirement accounts that have nothing to do with either. Knowing which mechanism actually applies to a given inheritance changes the entire picture.

The federal estate tax rarely applies, and it’s the estate’s problem, not the heir’s

The federal estate tax is paid by the estate before assets are distributed, not by the person who inherits — and as of 2026, it only applies to estates above $15 million per individual ($30 million for a married couple), an amount made permanent and indexed for inflation under recent tax law. According to the IRS, this threshold has risen sharply in recent years, which means the federal estate tax is a real planning consideration for a small number of large estates, but isn’t something most people inheriting from a parent or spouse need to weigh at all.

State inheritance tax is a different mechanism — and it’s the heir who owes it

Separately from the federal estate tax, five states currently levy their own inheritance tax: Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. This is the detail that surprises people — unlike the federal estate tax, a state inheritance tax is typically owed by the person receiving the inheritance, not the estate, and the rate often depends on the heir’s relationship to the deceased. Pennsylvania, for example, taxes a child inheriting from a parent at 4.5%, paid by the child directly. Maryland is the only state that layers both an estate tax and an inheritance tax on top of each other. Which state’s law applies generally depends on where the deceased lived or owned property — worth checking specifically if an inheritance crosses state lines.

Step-up in basis: why most inherited assets don’t carry the original owner’s gains forward

For assets like stocks, real estate, and other investments, the cost basis — the number capital gains tax gets calculated from — typically resets to the asset’s fair market value on the date of death, a mechanism called a step-up in basis. If a parent bought stock for $50,000 and it’s worth $100,000 at the time it’s inherited, the heir’s basis becomes $100,000, not $50,000 — meaning decades of unrealized gains the original owner never paid tax on simply disappear from a tax perspective. If the heir sells immediately at $100,000, there’s no capital gains tax owed at all. This applies to most assets in an estate, with one major exception below.

Inherited retirement accounts don’t get a step-up — and the withdrawal rules changed significantly

Traditional IRAs and 401(k)s are taxed differently because they represent money that was never taxed in the first place — withdrawals are taxed as ordinary income to the heir, the same as they would have been for the original owner, with no basis step-up available. The withdrawal timeline itself also matters more than it used to: under current rules, most non-spouse beneficiaries must empty an inherited retirement account within 10 years of the original owner’s death, a meaningful change from the “stretch IRA” rules that used to allow withdrawals over a beneficiary’s own lifetime. A small set of “eligible designated beneficiaries” — a surviving spouse, a minor child of the deceased (until age 21), someone chronically ill or disabled, or a beneficiary not more than 10 years younger than the deceased — are exempt from the 10-year rule and have other options. Whether annual withdrawals are required during that 10-year window, or all of it can be deferred to the final year, depends on whether the original owner had already started their own required withdrawals at death — a detail worth confirming directly with the account custodian or a tax professional, since getting it wrong can mean a penalty.

A few mechanisms worth knowing exist, even without a recommendation on using them

Some approaches that come up often enough in estate planning to be worth knowing about, without this being a recommendation to use any of them:

• Disclaiming an inheritance — a beneficiary can formally decline to receive an inheritance, which then passes to the next beneficiary in line, sometimes used when the original heir doesn’t need the assets and would rather they go to the next generation directly. This needs to be done correctly and within a specific timeframe to count for tax purposes.
• Lifetime gifting — some people transfer assets to heirs while still alive, within the annual gift tax exclusion, rather than waiting for those assets to pass through an estate. This intersects with the same lifetime exemption amount referenced above and is a genuinely different strategy with its own tradeoffs.
• Roth conversions before death — converting a traditional retirement account to a Roth during the original owner’s lifetime means the tax on that money gets paid once, at the original owner’s rate, rather than later by heirs at whatever their own rate happens to be when they’re forced to withdraw it.

Inheritance tax mechanics depend heavily on the specific assets involved, the state(s) in question, and the relationship between the deceased and the heir — a CPA or estate attorney familiar with the relevant state’s rules is the right next step for anything beyond general understanding, especially before a deadline like the inherited-IRA 10-year window is at stake.