How State Estate Taxes Differ from Federal Estate Taxes

How state estate taxes differ from federal estate taxes

Estate taxation in the United States operates on two levels: federal and, in some places, state. The federal estate tax is a single national tax imposed under federal law on the transfer of a decedent’s taxable estate. Separately, a smaller group of states impose their own estate taxes under state law. Those state systems can differ widely in who they tax, how they compute the taxable estate, the exemption (threshold) amount, the tax rates, and available credits or deductions.

Below I explain the practical differences you need to know when planning or administering an estate, outline common planning strategies, and link to resources and related FinHelp guides.

Key differences: scope and triggers

• Separate authority and filing: The federal estate tax is governed by federal law and enforced by the IRS; state estate taxes are governed by state law and administered by a state tax agency. Paying one does not eliminate the other.
• Exemption amounts: The federal exemption (sometimes called the basic exclusion amount) is indexed for inflation and has been in the multi-million-dollar range in recent years. Many state exemptions are far lower—some near $1 million—so an estate may escape federal tax yet still owe state estate tax.
• Rates and brackets: The federal estate tax applies to the taxable estate above the federal exemption and uses a top rate that has historically been high (up to 40%); states set their own rate schedules, which can be progressive and sometimes higher or lower than federal top rates.
• Timing and filing rules: States have different filing thresholds and deadlines. Some states require a state estate tax return even if nothing is due, while others only require a return when tax is owed.
• Inheritance taxes and differences: A few states impose an inheritance tax (a tax on recipients of inherited property) rather than an estate tax. The difference matters for planning: estate taxes are levied against the estate itself; inheritance taxes target heirs and beneficiaries.

(For an in-depth look at how specific states differ, see our guide on State-by-State Differences in Estate Tax and Probate Processes.)

How the taxable estate is calculated — where state rules diverge

Both federal and state systems start with the decedent’s gross estate: the fair-market value of probate and many nonprobate assets (real estate, retirement accounts, business interests, life insurance proceeds if owned by the decedent, etc.). From the gross estate you subtract allowable deductions (debts, funeral expenses, certain administrative costs, charitable bequests, and marital deductions). The result is the taxable estate.

States may differ in what they include or exclude: for example, some states have different rules for how they treat lifetime gifts, certain trusts, or nonresident-owned real estate. Careful valuation and classification matters because a small difference in what counts toward the taxable estate can push an estate over a state exemption and cause an unexpected tax bill.

Portability and spouse planning

At the federal level, an unused spousal exclusion (when a surviving spouse did not use all of the deceased spouse’s federal exclusion) can be transferred to the surviving spouse by filing an estate tax return and electing portability. Not all states conform to the federal portability rules; some have independent spousal provisions or no portability at all. Because portability is a one-time election requiring timely filing, it’s a common planning point in my work with married couples.

If you want a deeper explanation of portability and how to elect it, see our piece: What is Portability of the Estate Tax Exemption?.

Real-world implications and examples

• An estate with total assets above a state’s low exemption but below the federal threshold will not owe federal estate tax but may owe state estate tax. That outcome can surprise executors and heirs who only consider federal rules.
• Where state rates or brackets are aggressive, the state tax can meaningfully reduce the value passed to beneficiaries and may force the sale of closely held business interests or real estate to raise cash for taxes.

In my practice I’ve seen clients with sizable family farms or small businesses face immediate liquidity problems when a state death tax applied; planning options such as life insurance trusts or installment payment elections became crucial to avoid forced sales.

Common planning strategies to manage both state and federal exposure

1. Early and coordinated planning: Treat state and federal rules together. A plan built only around federal thresholds risks leaving state exposure unaddressed.
2. Lifetime gifting: Annual and lifetime gifts reduce the size of an estate. Many states count lifetime gifts differently; keep records and consider state look-back rules.
3. Trusts: Irrevocable trusts (including irrevocable life insurance trusts or ILITs) can remove assets from the taxable estate when correctly structured and funded. Trust terms and state law interact, so draft with state rules in mind.
4. Life insurance for liquidity: If a state estate tax is likely, owning life insurance inside or outside the estate (via an ILIT) can provide liquidity to pay taxes without forcing asset sales.
5. Use of marital and charitable deductions: Gifts to a surviving spouse or to charities reduce taxable estate under both systems, but the mechanics and limits may differ by state.
6. Business and real estate planning: Valuation discounts, family limited partnerships, and conservation easements can reduce estate values for tax purposes, but many states scrutinize or disallow aggressive valuations.
7. Consider residency and situs issues: State estate taxes often apply to residents on their worldwide assets and to nonresidents on property within the state. Moving residency late in life to avoid a state tax has rules and residency tests; it’s a complex tactic that requires professional advice.

For practical gifting approaches, see our guide: Gifting Strategies to Reduce Estate Tax Exposure.

When an estate owes both federal and state tax

An estate can owe both taxes, but most systems avoid double taxation on the same dollars through credits or deductions. Historically, the federal tax code allowed a credit for state death taxes; that credit was phased out and replaced with a deduction. Meanwhile, states have developed different approaches to avoid double taxing the same transfer. The interaction is technical, so executors should involve a qualified estate tax preparer and consider the timing of payments, liens, and refund claims.

Practical checklist for executors and planners

• Identify the decedent’s state of residence and the states where real property is located.
• Inventory all assets, including nonprobate items (retirement accounts, jointly held property, etc.).
• Determine state filing thresholds and whether a state return is required even if no tax is due.
• Evaluate liquidity needs to pay taxes and administrative costs; consider life insurance or installment payment elections for business assets.
• Check whether portability should be elected (requires timely federal return filing).
• Consult a state-licensed estate planning attorney or CPA experienced with that state’s estate tax law.

Common pitfalls and misconceptions

• “No federal tax means no tax at all.” Not true — many states tax estates well below the federal exclusion.
• “All states work the same.” State laws differ on definitions, look-back periods for gifts, valuation rules, and credits.
• “Moving shortly before death avoids state tax.” States often apply residency tests and look at intent and time lived in the state; quick moves are scrutinized.

Administration notes and deadlines

Federal estate tax returns are generally due within nine months after death, with the option to request an extension; state deadlines and extension rules vary. Because missing a timely filing can forfeit elections (for example, portability), executors should prioritize early contact with a tax advisor.

Resources and reliable references

• IRS — Estate and Gift Taxes (official federal guidance): https://www.irs.gov/businesses/small-businesses-self-employed/estate-and-gift-taxes
• Tax Policy Center — materials on federal estate tax policy and analysis: https://www.taxpolicycenter.org/briefing-book/what-estate-tax

This FinHelp article is part of a larger set of estate planning resources. Related reading: our guide on State-Specific Estate Tax Triggers: What to Watch For and What is Portability of the Estate Tax Exemption?.

Professional perspective: In my practice helping families and small-business owners, I find the most costly mistakes arise when planning relies solely on federal rules. Even estates well under the federal exclusion can face significant state-level taxes, and the right mix of trusts, gifting, and liquidity planning can prevent forced sales of family assets.

Disclaimer: This article is educational and does not substitute for personalized legal, tax, or financial advice. State and federal laws change; consult a qualified estate planning attorney or CPA licensed in your state to apply these concepts to your situation.