Estate tax and inheritance tax are different taxes on different people for the same event, and the thresholds and rates that decide the bill change with every legislature — so this guide describes the structure, not the figures. The U.S. federal and state systems, the UK nil-rate band and seven-year rule, the reliefs, the planning, and the liquidity problem that makes a tax bill into a forced sale.

Two taxes, two different events

Estate tax and inheritance tax are routinely confused, because both are taxes that arise when someone dies, and both are described, loosely, as “death taxes”. They are different taxes, levied by different governments, on different people, for different events. Estate tax is levied on the estate of the person who died — on the total value of what they left — and it is paid by the estate, out of the estate’s assets, before anything is distributed. Inheritance tax is levied on the person who receives — on the share each beneficiary inherits — and it is paid by the beneficiary, on the amount they receive, at a rate that may depend on their relationship to the person who died. A transfer can therefore be subject to one, to the other, to both, or to neither, depending on where the person lived, where the property is, and who receives it. The first question in any estate plan is which tax, or taxes, apply — and the answer is a matter of jurisdiction, not of the size of the estate alone.

In the United States, the federal tax is an estate tax: it is levied on the estate, it has a large exemption, and it applies to very few estates. A handful of states levy their own estate tax, with smaller exemptions, and a smaller handful levy an inheritance tax instead, on the beneficiaries, with rates that vary by the beneficiary’s relationship to the deceased. In the United Kingdom, the tax is called inheritance tax, but it operates as an estate tax: it is levied on the estate, paid by the executors, and the rate is flat above the threshold, with reliefs for spouses, charities, and specific kinds of property. The name and the mechanism do not always match, and the guide that follows uses the mechanism — who pays, on what, at what rate — rather than the name, because the mechanism is what decides the bill.

United States federal estate tax: the exemption and the rate

The federal estate tax applies to the taxable estate: the gross estate — everything the deceased owned at death, including property, investments, business interests, and the proceeds of life insurance the deceased owned — minus the deductions the law allows, including debts, funeral and administration expenses, charitable bequests, and the unlimited marital deduction for property passing to a surviving spouse who is a U.S. citizen. The tax is computed on the taxable estate, at a flat top rate, after applying the unified credit, which shelters an amount up to the exemption for the year. The exemption is large and it is indexed: it is set by law for each year, it has been raised and lowered by successive legislation, and it is scheduled to change, which makes the exemption for the year of death — not the year of planning — the figure that matters, and makes any printed figure in a guide a hostage to the next Act of Congress. This guide therefore does not print the exemption or the rate as current facts; it describes the structure and directs the reader to the IRS figures for the year of death, which are the only figures that decide the bill.

Two features of the federal system matter more than the rate. The first is portability: the unused exemption of a predeceased spouse may be transferred to the surviving spouse, by election on the predeceased spouse’s return, so that a couple’s combined exemption can shelter a larger estate than either spouse’s alone. Portability must be elected — it is not automatic — and the election requires a return to be filed for the predeceased spouse even where no tax is due, which is the step most often missed, and the most expensive to miss, because the unused exemption is lost without it. The second is the annual gift exclusion and the lifetime gift exemption: gifts within the annual exclusion are not taxable gifts, gifts above it use lifetime exemption, and the estate and gift taxes are unified, so that lifetime gifts reduce the exemption available at death. Lifetime giving and estate planning are one computation, not two, and a gift programme that ignores the lifetime exemption will exhaust at death the shelter it meant to preserve.

State estate and inheritance taxes: smaller exemptions, different payers

State death taxes are where most estates that owe anything actually owe it, because the state exemptions are far smaller than the federal one. A state estate tax, levied on the estate like the federal tax, may exempt only a fraction of the federal amount, so that an estate well below the federal threshold owes state tax. A state inheritance tax, levied on the beneficiary, exempts or taxes at different rates according to relationship: a spouse is usually exempt, children and grandchildren are taxed at a lower rate, and more distant relatives and unrelated beneficiaries are taxed at a higher rate, on the share each receives. The two kinds of state tax can coexist — an estate can owe a state estate tax on the whole and a state inheritance tax on the shares — and the property’s location decides which states can tax it: real property is taxed where it sits, and personal property where the deceased lived, with credits between states to reduce, but not always eliminate, double taxation on the same property.

The planning consequence is that residence and property location are tax decisions. An estate with property in a state with an inheritance tax and a residence in a state without one faces both systems; an estate that moves residence, or that holds property through an entity, changes the answer. The state figures — the exemptions, the rates, the relationship classes — change frequently and differ widely, and they must be taken from the state’s own revenue department for the year of death. A guide that printed them would be wrong for most readers within a year, and the honest guide describes the structure, names the states that levy each kind, and directs the reader to the state’s figures. The structure is durable; the figures are not.

United Kingdom inheritance tax: the nil-rate band and the reliefs

United Kingdom inheritance tax is charged on the estate at death, at a flat rate above the nil-rate band — the threshold below which no tax is due — with the residence nil-rate band adding a further threshold where the home passes to direct descendants and the estate is below a limit. Transfers between spouses and civil partners are exempt, and the unused nil-rate band of a predeceased spouse may be transferred to the survivor, in the same portability pattern as the U.S. federal system. Charitable bequests are exempt, and a bequest of a sufficient proportion of the estate to charity reduces the rate on the remainder. Gifts made during life are potentially exempt transfers: a gift is exempt if the donor survives seven years, and it is taxed on a sliding scale if the donor dies within seven years, with the tax falling as the years pass. The seven-year rule is the centre of UK lifetime planning, and it is a rule about time, not about amount: a gift made seven years before death escapes the tax entirely, whatever its size, and a gift made six years before death is taxed, with taper relief reducing the tax as the seven years are approached.

The UK reliefs for business and agricultural property — business property relief and agricultural property relief — can remove the whole value of a qualifying business or farm from the taxable estate, and they are the most valuable reliefs in the system for the estates that qualify. The reliefs have conditions: the property must be a qualifying business or agricultural property, held for the qualifying period, and used for the qualifying purpose, and the relief is lost where the conditions are not met at death. The conditions are technical, the valuations are contested, and the planning must be done while the owner is alive and the business is operating, because the relief follows the property’s use, not the owner’s intention. An estate that claims the relief without the qualifying use invites a challenge, and a business that qualifies but is not documented as qualifying loses the relief for want of evidence. The reliefs reward the business that is genuinely run as a business, and they punish the business that is merely held.

The four systems compared by mechanism. The names are not reliable guides — the UK tax is called inheritance tax but is levied on the estate — and the figures must be taken from the official source for the year of death.

Thresholds and rates: why no figures are printed

This guide prints no thresholds or rates for estate and inheritance taxes, and the omission is deliberate. The federal exemption is set by legislation that changes it, the state exemptions and rates change with state budgets, and the UK nil-rate band and residence nil-rate band are frozen, raised, or reformed with each Budget. A figure printed in a guide is a figure frozen at the guide’s date, and a reader who relies on it for an estate plan made years later will plan against the wrong threshold, with consequences measured in tens or hundreds of thousands. The thresholds and rates for the year of death are published by the IRS, by the state revenue departments, and by HM Revenue & Customs, and they are the only figures that decide a bill. The guide’s contribution is the structure — what is taxed, who pays, what is exempt, and what can be transferred — because the structure changes slowly, while the figures change with every legislature.

What can honestly be said about the figures is their shape. The federal estate tax reaches very few estates, because the exemption is very large; the state taxes reach more, because their exemptions are smaller; the UK tax reaches more still, because the nil-rate band is modest against house prices in the south-east, and the residence nil-rate band, where it applies, is the relief that most often decides whether a family home’s estate pays tax at all. The rates, where they apply, are flat or mildly graduated in the UK, flat at the top in the U.S. federal system, and graduated by relationship in the inheritance-tax states. The shape is the planning insight: the federal tax is a tax on very large estates, the state taxes are taxes on moderately large estates, and the UK tax is a tax on the family home, and the planning for each starts from a different place.

Planning: gifts, trusts, and the seven-year and lifetime rules

Lifetime giving is the principal planning tool in both systems, and it works differently in each. In the United States, gifts use the annual exclusion and then the lifetime exemption, unified with the estate tax, so that a gift programme spends the same shelter the estate would use at death: giving during life does not create new exemption, it uses the existing one earlier, and the benefit of giving is the removal of future appreciation from the estate, not the creation of shelter. In the United Kingdom, gifts that survive seven years escape the tax entirely, creating shelter that the estate would not have had, and the benefit is the whole tax on the gifted amount, provided the donor survives. The two systems therefore reward different behaviour: the U.S. system rewards giving assets that will appreciate, early, so the appreciation escapes; the UK system rewards giving, surviving, and giving again, in a rolling seven-year programme. A plan that applies one system’s logic to the other’s law wastes the opportunity in both.

Trusts are the second tool, and they are instruments, not shelters in themselves. A trust that holds assets for beneficiaries, with trustees who manage them, can remove assets from the taxable estate, provide for beneficiaries who cannot manage property themselves, and control the timing of distributions — and it can also create tax charges of its own, periodic and on exit, that must be counted against the benefit. The trust’s tax treatment depends on its type, its jurisdiction, and the powers retained by the settlor: a trust from which the settlor retains a benefit is not removed from the estate, in either system, and a trust created to avoid tax, without a genuine non-tax purpose, is challenged under the anti-avoidance rules. Trusts should be created for a real purpose — providing for a minor, protecting a vulnerable beneficiary, managing a business — with the tax counted as a consequence, not as the purpose, and they should be created with advice, because the deed, once executed, is difficult to unwind, and the tax charges it creates are difficult to reverse.

Paying the tax: liquidity, instalments, and the family home

Estate tax is payable in cash, on a deadline, on an estate that may consist mostly of property that cannot be sold quickly — and the liquidity problem is the most painful feature of the tax for families. The U.S. federal tax is due nine months after death, with an extension for filing and, in limited circumstances, for payment, and interest runs on the unpaid amount. The UK tax is due six months after the end of the month of death, with instalments available for certain property, including land and business property, spread over ten years, with interest on the outstanding balance. A family that inherits a house and a tax bill, with no cash to pay it, faces a forced sale, and the planning that prevents it is life insurance — a policy written in trust, so that its proceeds are not part of the taxable estate and are available to pay the tax — or a liquid reserve, built over the owner’s lifetime for exactly this purpose. The insurance must be arranged while the owner is insurable, and the trust must be established correctly, because a policy owned by the deceased is part of the estate it was meant to save.

The family home deserves a specific note, because it is the asset most estates consist of and the asset the reliefs most often target. In the UK, the residence nil-rate band shelters the home passing to direct descendants, up to a limit, where the estate is below the taper threshold; in the U.S., the home is part of the gross estate like any other asset, and the marital deduction shelters it where it passes to a spouse, but not where it passes to children. Downsizing provisions in the UK preserve the residence relief where the owner sold a more valuable home and the proceeds are in the estate, and the provisions are technical, with claims and time limits that must be observed. The home should be valued correctly — by a professional valuation, not by an estate agent’s estimate — because the value decides the tax, and the valuation is the evidence the revenue authority will test. A home undervalued on the return invites an enquiry; a home overvalued pays tax that was never due.

Filing, executors, and the personal representative’s risk

The return is filed by the personal representative — the executor or administrator — who is personally liable for the tax, up to the value of the assets distributed, if the tax is not paid before distribution. The representative must therefore ascertain the estate, value it, claim the reliefs, file the return, pay the tax, and only then distribute, in that order, and a distribution made before the tax is settled is made at the representative’s risk. The return requires a complete inventory: every asset, every debt, every gift within the relevant period — seven years in the UK, the lifetime record in the U.S. — and every relief claimed, with the evidence for each. The representative who distributes early, or who omits a gift, or who claims a relief without the qualifying evidence, bears the consequence personally, and the beneficiaries who received the distribution may be pursued for the tax. The discipline is the same as for every tax in this programme: the records, kept during life, decide the return after death, and the return that is complete and evidenced is the return that is accepted.

Frequently asked questions

What is the difference between estate tax and inheritance tax?

Estate tax is levied on the estate of the person who died, on the total value left, and is paid by the estate before distribution. Inheritance tax is levied on each beneficiary, on the share they receive, and is paid by the beneficiary, often at a rate depending on their relationship to the deceased. The U.S. federal tax is an estate tax; some states levy inheritance taxes; the UK tax is called inheritance tax but is levied on the estate. A transfer can be subject to one, both, or neither, depending on jurisdiction.

Who pays estate tax in the United States?

The estate pays, out of its assets, before anything is distributed, and the personal representative is liable for the tax up to the value distributed. The federal tax applies only above a large exemption, which is set by law for the year of death and is scheduled to change, so the IRS figures for the year of death are the only figures that decide the bill. State estate and inheritance taxes, with smaller exemptions, are where most estates that owe anything actually owe it.

What is the UK inheritance tax nil-rate band?

The threshold below which no inheritance tax is due, with the residence nil-rate band adding a further threshold where the home passes to direct descendants and the estate is below a limit. Transfers between spouses and civil partners are exempt, the unused nil-rate band of a predeceased spouse may be transferred, and charitable bequests are exempt. Gifts made during life are potentially exempt transfers, escaping tax entirely if the donor survives seven years. The current figures are published by HM Revenue and Customs and change with Budgets, so no figures are printed here.

Do beneficiaries pay tax on what they inherit?

It depends on the jurisdiction. Under an estate tax, the beneficiary receives the share after the estate has paid the tax, and the receipt itself is not income. Under an inheritance tax, the beneficiary pays tax on the share received, at a rate depending on their relationship to the deceased. In either case the beneficiary may owe income tax later on income the inherited assets produce, and capital gains tax on a later sale, measured from the value at death.

How can estate tax be reduced by lifetime giving?

In the United States, gifts use the annual exclusion and then the unified lifetime exemption, so giving removes future appreciation from the estate but spends the same shelter the estate would use. In the United Kingdom, gifts that survive seven years escape tax entirely, creating shelter the estate would not have had. The two systems reward different behaviour, and a plan should follow the law of the jurisdiction that will tax the estate, with the gifts documented and the survival period in mind.

What happens if an estate cannot pay the tax?

The tax is payable in cash on a deadline — nine months after death in the U.S. federal system, six months after the month of death in the UK — and interest runs on unpaid amounts. The UK allows instalments over ten years for certain property, including land and business property. The usual planning is life insurance written in trust, so the proceeds are outside the taxable estate and available to pay the tax, or a liquid reserve built for the purpose. The personal representative must pay the tax before distributing, at personal risk if they distribute early.