The federal estate tax is charged on the transfer of a person's estate to her heirs. Some states in the United States charge an inheritance tax on top of the federal estate tax. The inheritance system taxes almost all transfers of property at death. Transfers to spouses and charities are exempt from estate taxes.
Estate Tax
The federal government taxes the transfer of property both while you are alive and when you die. Transfers while you are alive are charged gift taxes while transfer at death are charged the estate tax. The estate tax is charged on the gross estate left to your beneficiaries. Everything you own while alive is included in your gross estate, including cash, property, investments and business interests. As of 2011, you are allowed to transfer up to $5 million of a gross estate tax-free. If your gross estate is over $5 million, you may owe federal estate taxes.
State Inheritance Tax
The inheritance system of some states also taxes your right to transfer property at death. The states that charge an estate tax are Connecticut, Delaware, District of Columbia, Hawaii, Maine, Maryland, Massachusetts, Minnesota, New Jersey, New York, Ohio, Oregon, Rhode Island, Vermont, and Washington. The other states do not charge an inheritance tax. The estate tax rate for states is lower than the federal estate tax rate; however, the exemption for an estate is lower for state taxes. For example, in New Jersey you are only allowed to exempt $675,000 from estate taxes.
Tax Payment
When you die, an executor is appointed to manage and distribute your gross estate. One of the duties of the executor is to determine if any estate taxes are due to the federal or state government. He will add up the fair market value of everything you own at death to calculate your gross estate. He will then subtract the federal and state exemption amounts from your estate. If your estate is larger than either exemption, taxes will be due on your estate. The executor will file an estate tax return with the government and pay the taxes out of your estate.
Exceptions
Not all transfers at death are charged taxes. Federal and state governments allow a deduction for transfers made to your spouse or to charity. You are allowed an unlimited deduction from your estate for all property left to your spouse. This deduction is only for your spouse, and transfers to other family members can be taxed. To encourage donations, the government also allows an unlimited deduction for any property you bequest to charity.
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