How Are Estate Taxes Calculated? | The Real Numbers

The federal estate tax applies only to the portion of an estate’s value exceeding the exemption — $13.99 million per individual in 2025 —.

You may have heard horror stories about family farms and small businesses being broken up to pay estate taxes. In practice, that scenario is vanishingly rare. The federal exemption is high enough that fewer than 0.1% of estates end up owing anything to the IRS.

Understanding how the tax is calculated matters whether your net worth is modest or substantial. The process involves valuing everything the deceased owned, subtracting specific deductions, and then applying a progressive tax rate only to the amount above the exemption.

What Goes Into the Gross Estate

The starting point for any estate tax calculation is the gross estate. This includes the fair market value of all property the deceased owned or had an interest in at the date of death. Real estate, stocks, bonds, business interests, and life insurance proceeds (if the deceased held ownership rights) all count.

Valuation uses current market prices or appraisals. A house bought for $100,000 that is now worth $400,000 enters the gross estate at its $400,000 market value. The same principle applies to investments — mutual funds and retirement accounts are valued at the closing price on the date of death.

Not everything included in the gross estate is subject to tax. The IRS allows you to subtract debts, funeral expenses, administrative costs, mortgages, and charitable bequests from the total before tax is computed.

Why Most Families Won’t Face This Tax

The common worry that estate taxes will wipe out an inheritance is largely unfounded for the vast majority of households. The federal exemption is so generous that only the wealthiest estates trigger a filing requirement. But the psychology of “what if” keeps people asking about the math.

Here are the key numbers that explain why most estates pay nothing:

• Federal exemption for 2025: $13.99 million per individual, meaning a single person can leave that amount tax-free. Married couples can combine exemptions for up to $27.98 million.
• Sunset on the horizon: The current exemption is scheduled to drop at the end of 2025 to roughly $5–7 million (adjusted for inflation) unless Congress extends it. This could affect more estates in 2026 and beyond.
• State estate taxes: 17 states and the District of Columbia levy their own estate tax, often with lower thresholds. For example, Washington state’s exemption is around $2.2 million, so even moderate estates there may owe state tax.
• Inheritance taxes are different: Only five states impose an inheritance tax, which is paid by the heir rather than the estate. Kentucky, for instance, charges 4%–16% depending on the beneficiary’s relationship to the deceased.

Because of the high federal exemption, most people will never need to file Form 706. The calculation becomes relevant primarily for high-net-worth families and residents in states with their own estate tax.

How the Tax Is Actually Calculated

Once the gross estate is valued, you subtract all allowable deductions to arrive at the taxable estate. The most common deductions include funeral expenses, administration costs (legal and executor fees), outstanding debts, mortgages, and gifts to qualifying charities. After deductions, the remaining amount is compared to the exemption — only the excess is taxed.

The federal rate schedule is progressive: starting at 18% on the first $10,000 of taxable amount and rising to 40% on amounts over $1 million. In practice, the effective rate on the portion above the exemption typically lands near 40% because most taxable estates far exceed the lowest brackets.

State rates can differ significantly. For example, Washington estate tax rates start at 10% on the first $1 million of taxable estate and climb to 15% on amounts between $1 million and $2 million — a much lower threshold than the federal exemption.

Key Factors That Change the Bill

The final estate tax liability depends on more than just the total value. Several variables can raise or lower the amount owed:

1. Portability between spouses. A surviving spouse can inherit the deceased partner’s unused exemption, effectively doubling it for the couple’s combined estate. This election must be made on a timely filed Form 706.
2. Lifetime gifts. Money given away during life can reduce the gross estate. The annual gift tax exclusion in 2025 is $19,000 per recipient. Larger gifts eat into the lifetime exemption, which is unified with the estate tax exemption.
3. State tax interplay. Some states allow a deduction for state estate taxes paid, which can lower the federal tax. Others, like Washington, offer no such offset. The total combined tax burden varies widely by jurisdiction.
4. Qualified business or farm land. Special use valuation may allow certain real property used for farming or business to be valued at its current use rather than its highest market value, reducing the gross estate.

Each of these factors can meaningfully change the tax calculation. For example, a couple with a $30 million estate who properly uses portability and annual gifts may owe less than a single person with a $15 million estate who made no such plans.

State Taxes Add Another Layer

While the federal estate tax captures headlines, state-level taxes often affect far more families. States with estate taxes set their own exemption amounts, which are generally much lower than the federal level. A family may owe nothing to the IRS but still face a significant state tax bill if they live in or own property in a state with an estate tax.

The IRS defines gross estate broadly, but states may have different rules for what counts and what can be deducted. In Washington, the taxable estate starts after a $2.2 million exemption, and rates are graduated. Kentucky, on the other hand, levies an inheritance tax based on the heir’s relationship to the deceased, not on the estate itself.

Because state rules vary so much, it’s essential to check the laws of your specific state and any state where you own property. A professional who specializes in estate taxation for your jurisdiction can provide accurate guidance.

The Bottom Line

Estate tax calculations follow a consistent three-step process: valuing the gross estate, subtracting deductions, and applying a progressive rate to the amount above the exemption. The federal exemption is high enough that most estates owe nothing, but changes coming in 2026 and state-level taxes mean planning still matters.

If your net worth is near or above the exemption threshold — or if you live in a state with its own estate tax — a qualified estate planning attorney or CPA can help you estimate your potential liability and explore strategies like lifetime gifting or trusts to reduce it.

Your family’s specific assets, debts, and state of residence all affect the final number — a conversation with a fiduciary advisor familiar with both federal and your state’s rules is the surest way to get a reliable estimate.