Tax Obligations During Probate: Income, Estate, and Inheritance Tax Guide

The Tax Rules of Probate Administration

Death triggers up to four distinct tax regimes, and you'll probably hit at least two on any non-trivial estate. There's the federal estate tax at 40% above the $13.99M 2025 exclusion.

There are state estate taxes in twelve states plus DC, often at lower exclusion thresholds (Massachusetts starts at $1M). There are inheritance taxes in five states — Kentucky, Maryland, Nebraska, New Jersey, Pennsylvania — assessed against beneficiaries. And there are income taxes: the estate's own income during administration (Form 1041), the decedent's final Form 1040, and potential income tax on distributions to beneficiaries.

Understanding which taxes apply, when they're due, and how they interact isn't optional for probate counsel — it's core competency. Missing a filing deadline or misidentifying a taxable transfer exposes the estate and the attorney to liability.

This guide provides a systematic overview referencing the applicable IRS forms and guidance. For the multistate dimension, our guide on multistate estate tax goes deeper.

The Tax Foundation (taxfoundation.org) maintains current data on state estate and inheritance tax rates and thresholds — a useful reference when you're quickly sizing up a new matter's state tax exposure.

Federal Estate Tax: Current Exemption and Rates

The federal estate tax is imposed on the transfer of the taxable estate of every U.S. citizen and resident alien at death. The tax rate is 40% on taxable amounts above the applicable exclusion amount.

For 2025, the exclusion is $13.99 million per individual, indexed for inflation. This exclusion encompasses both the basic exclusion amount and any deceased spousal unused exclusion (DSUE) carried over from a predeceased spouse, as discussed below in the portability section.

A taxable estate is calculated by taking the gross estate (all assets in which the decedent had an interest at death, including certain non-probate transfers), deducting allowable deductions (marital deduction, charitable deduction, debts and claims against the estate, administration expenses, and losses), and arriving at the taxable estate. The IRS Form 706 instructions provide a detailed roadmap; practitioners who file 706s regularly should review the instructions for each filing year, as line items change.

The critical planning context is that the elevated exclusion under the Tax Cuts and Jobs Act is scheduled to sunset after 2025, reverting to approximately $6 to $7 million (indexed for inflation). Clients whose estates fall in the gap between the current and post-sunset exclusion amounts should be taking action now, as discussed in the irrevocable trusts and asset protection guide on this site.

State Estate Taxes: Twelve States Plus DC

Twelve states and the District of Columbia impose their own estate taxes, often with exclusion amounts significantly lower than the federal threshold. Washington State has a $2.193 million exclusion (2024) with rates up to 20%.

Oregon's exclusion is $1 million. Massachusetts and Oregon both have $1 million exclusions—meaning a Massachusetts resident with a $2 million estate that owes no federal estate tax may still owe significant state estate tax.

The states with estate taxes as of 2024 include Connecticut, Hawaii, Illinois, Maine, Maryland, Massachusetts, Minnesota, New York, Oregon, Rhode Island, Vermont, Washington, and the District of Columbia. Maryland is unique in imposing both a state estate tax and an inheritance tax. State estate tax rates vary from approximately 8% to 20% depending on the state and the estate value.

For clients with real estate or business interests in multiple states, the domicile determination is critical: the state of domicile taxes the full taxable estate, while other states can only impose estate tax on real property and tangible personal property located within their borders. Planning for state estate taxes requires understanding the siting of assets and the domicile rules, issues addressed in detail in the multistate estate tax planning guide.

Inheritance Tax: The Six-State Framework

Inheritance tax is conceptually different from estate tax: it is assessed against the beneficiary receiving property from a decedent, not against the estate itself. Five states currently impose inheritance tax: Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania.

Iowa eliminated its inheritance tax effective January 1, 2025. The rates and exemptions vary by beneficiary class, with surviving spouses and lineal descendants (children, grandchildren) often exempt or subject to lower rates, while non-family beneficiaries face the highest rates.

Pennsylvania's inheritance tax is among the most significant for probate practitioners: it applies at 4.5% for transfers to lineal descendants, 12% for siblings, and 15% for other heirs. Pennsylvania does not exempt the transfer to a surviving spouse (0% rate for spouses). New Jersey imposes rates up to 16% for Class C and D beneficiaries, with no tax on transfers to a surviving spouse, children, grandchildren, or parents.

When advising clients in inheritance tax states, it is important to distinguish between probate and non-probate transfers. Life insurance payable to a named beneficiary, IRA distributions, and jointly-held property may still be subject to inheritance tax even though they bypass probate. Practitioners should verify the state's rules on non-probate transfers before advising clients that a trust or beneficiary designation arrangement avoids inheritance tax consequences.

Estate Income Tax: Form 1041

An estate is a separate taxable entity for income tax purposes, and the executor is responsible for filing Form 1041 (U.S. Income Tax Return for Estates and Trusts) for any taxable year in which the estate has gross income of $600 or more. The estate's tax year begins on the date of death and can be a calendar year or a fiscal year elected by the executor on the first Form 1041 filed. A fiscal year election can provide significant income-shifting opportunities by controlling when income is distributed to beneficiaries.

The estate pays income tax at compressed rates: the highest ordinary income tax rate (37% as of 2025) applies to undistributed income above $15,450. Distributions of income to beneficiaries generate a deduction for the estate (the distributable net income deduction) and are taxable to the beneficiaries at their individual rates. This creates planning opportunities: distributing income to beneficiaries in lower tax brackets reduces the overall income tax burden.

Estate income commonly includes interest, dividends, rental income, business income, and capital gains from the sale of estate assets during administration. The treatment of capital gains is particularly important: depending on whether gains are allocated to income or corpus under the trust accounting rules and the trust instrument, they may or may not be eligible for the DNI deduction and distribution to beneficiaries.

Step-Up in Basis and DSUE Portability

The basis step-up under IRC §1014 is one of the most valuable income tax benefits associated with death. Assets included in the decedent's taxable estate receive a new basis equal to fair market value at the date of death (or the alternate valuation date), eliminating the built-in capital gain that accumulated during the decedent's lifetime. For clients who held appreciated assets for decades, this can represent an enormous income tax savings for heirs.

The step-up applies only to assets included in the taxable estate. Assets in irrevocable grantor trusts may not receive a step-up if they are not included in the estate—a significant planning consideration when advising clients on the trade-off between estate tax savings and income tax basis. Some practitioners deliberately include assets in the estate (using powers of appointment or similar mechanisms) specifically to secure the basis step-up.

Portability of the deceased spousal unused exclusion (DSUE) allows a surviving spouse to use any portion of the predeceased spouse's federal estate tax exclusion that was not used at the first death. The executor must elect portability on a timely filed Form 706 (or a late-filed 706 filed solely for the portability election under Rev. Proc.

2022-32). The DSUE can then shelter gifts and bequests at the surviving spouse's death.

For married couples with combined estates below the federal exclusion, portability is often simpler than credit shelter trust planning. As discussed in our guide on how probate costs are calculated, the estate tax return itself has professional fee implications that clients should understand from the outset.