Most grandchildren do not pay federal inheritance tax because the United States has no federal inheritance tax. However, your grandchildren might pay federal estate tax if your estate exceeds $13.99 million in 2025, or they might pay state inheritance tax if they live in one of five states with these taxes. A federal rule called the generation-skipping transfer (GST) tax can also apply to direct gifts to grandchildren that exceed certain limits. Understanding these different taxes will help you plan your family’s wealth transfer.
Here’s what you’ll discover in this article:
🏦 The difference between federal estate tax and state inheritance tax, and how each affects grandchildren
💰 Exactly when grandchildren pay taxes and when they don’t, with real examples from common family situations
📋 How the generation-skipping transfer tax works and the exemptions available to avoid it
🏠 Smart planning strategies grandparents can use right now to minimize taxes for grandchildren
⚠️ Common mistakes families make when leaving money to grandchildren and how to sidestep them
Understanding Federal Estate Tax Versus State Inheritance Tax
Your grandchildren face two separate tax systems when they inherit: federal law and state law. The federal government operates an estate tax system that applies when your total estate exceeds the exemption limit, but there is no federal inheritance tax. This means the tax is paid by your estate before assets go to grandchildren, not by grandchildren themselves.
An estate tax applies to the entire value of what you own when you die. Your estate includes cash, investments, property, retirement accounts, and life insurance. The federal estate tax exemption for 2025 is $13.99 million per person, and married couples can shield $27.98 million together. Any amount above these limits gets taxed at 40% by the federal government.
State inheritance taxes work differently. Only five states have inheritance tax systems: Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. An inheritance tax is paid by beneficiaries, meaning your grandchildren would owe the tax, not your estate. These state taxes depend on how closely your grandchildren are related to you. In most of these states, grandchildren are fully exempt from inheritance tax simply because they are your direct descendants.
The key distinction matters for planning: if your estate is large and you live in a state with no inheritance tax, your grandchildren might inherit freely even if federal estate tax applies. But if you live in Pennsylvania, Maryland, or one of the other five states, you need to check if they impose inheritance tax on anyone other than spouses, parents, and close family members.
Federal Estate Tax: When Does Your Estate Pay?
Your estate pays federal estate tax, not your grandchildren. This means the tax comes out of your total assets before grandchildren receive their inheritance. The 2025 federal exemption is $13.99 million per person, which is quite high. For example, if your total estate is worth $10 million, your grandchildren inherit the full $10 million with no federal tax.
However, this exemption has an expiration date. The current high exemption amounts are temporary under a law passed in 2017. The exemptions expire at end 2025, which means the exemption could drop to approximately $7 million per person in 2026 unless Congress acts to extend it. This is a critical planning point for grandparents with substantial assets.
When estate tax does apply, it takes money directly from your estate. If your estate is worth $15 million and you die in 2025, the taxable amount is $1 million ($15 million minus the $13.99 million exemption). The federal government takes 40% of that $1 million, which is $400,000. The remaining $14.6 million goes to your grandchildren. Your estate’s executor pays this tax using estate assets before the inheritance reaches grandchildren.
State Inheritance Tax: Direct Taxes on Grandchildren
Unlike federal estate tax, state inheritance taxes are paid by your beneficiaries directly. This means your grandchildren would owe the tax themselves in these five states. The good news is that in most of these states, grandchildren pay zero tax because they are direct descendants of the deceased.
In New Jersey, surviving spouses, children, grandchildren, and parents are completely exempt from inheritance tax. This means your grandchildren pay nothing, regardless of how much they inherit. The same exemption applies in Maryland, where spouses, children, grandchildren, and parents are all exempt.
In Kentucky, grandchildren and other direct descendants are exempt from inheritance tax. However, siblings and more distant relatives face rates up to 16%. In Pennsylvania, grandchildren pay only 4.5% tax, which is the lowest rate in the state. This applies to all direct descendants and lineal heirs.
In Nebraska, grandchildren qualify as “immediate relatives” and are taxed at just 1% on amounts over $100,000. If a grandchild inherits $200,000, they owe tax on only $100,000 (the amount over the exemption), which would be $1,000. Iowa completely repealed its inheritance tax, with the tax phasing out by 2024.
The Generation-Skipping Transfer Tax: A Hidden Tax Trap
The generation-skipping transfer (GST) tax is a federal tax that catches many grandparents by surprise. This tax applies when you transfer assets directly to grandchildren, either during your lifetime as gifts or through your will. The IRS created this tax in 1976 to prevent wealthy families from skipping over a generation to avoid paying tax twice.
The GST tax rate is a flat 40%, applied in addition to any gift or estate tax already owed. This means if you leave $1 million to a grandchild and GST tax applies, the IRS takes $400,000, leaving the grandchild with only $600,000. That’s a massive tax hit that most grandparents never anticipate.
A “skip person” includes your grandchildren, other relatives who are more than one generation below you, and unrelated people who are more than 37½ years younger than you. However, there is one important exception: if a grandchild’s parent dies before you, the grandchild moves up a generation and is no longer considered a skip person. This rule helps families where children pass away early.
The GST tax doesn’t apply to transfers where you allocate your GST tax exemption, and the annual GST tax exclusion allows you to transfer up to $19,000 per year in 2025 to any number of skip persons without triggering GST tax. Your lifetime GST exemption is $13.99 million in 2025, which is the same as your federal estate tax exemption. This means you can leave $13.99 million to your grandchildren without any GST tax.
There are three types of transfers that trigger GST tax: a direct skip (a transfer directly to a skip person subject to federal gift and estate tax), a taxable distribution (a distribution from a trust to a skip person), and a taxable termination (such as when you establish a trust for your children and when the last child dies, assets pass to grandchildren).
How Inheritance Works When Your Child Passes Away First
A crucial planning scenario involves what happens when your child (the grandchild’s parent) dies before you. Due to intestate succession laws, if a grandparent dies without a will, any property that would pass to a deceased parent passes directly to their children. This means grandchildren automatically inherit their grandparent’s assets.
However, if your grandparent didn’t account for grandchildren in their will, it’s entirely possible they will not receive an inheritance. This is why having a clear will or trust that specifically names grandchildren is critical. If you want your grandchildren to inherit in the event their parent dies before you, you must state this explicitly in your estate documents.
The tax advantage when a child dies first is significant for GST tax purposes. When a grandchild’s parent predeceases you, the grandchild moves up a generation and is no longer considered a skip person. This means the GST tax does not apply, and you can leave unlimited amounts to that grandchild without the 40% generation-skipping transfer tax. This creates a major planning opportunity if you know your child is ill or in poor health.
The Step-Up in Basis Advantage for Inherited Assets
Your grandchildren receive a massive tax benefit when they inherit assets through your estate: a step-up in basis. The step-up in basis rule can dramatically reduce capital gains tax when an asset is sold after inheritance. This rule applies to most assets inherited through your will or trust.
Here’s how it works: when you buy a stock for $10,000 and it grows to $50,000 by the time you die, your grandchild inherits it at the current market value of $50,000. If your grandchild sells the stock immediately for $50,000, they owe zero capital gains tax because their basis (their starting value) is $50,000. The inherited asset receives a step-up in basis to the fair market value on the date of death. Your grandchild never pays tax on the $40,000 gain that happened during your lifetime.
Without step-up in basis, if you gave that same $50,000 stock to your grandchild while you were alive, your grandchild would inherit your original basis of $10,000. When they sell it for $50,000, they owe capital gains tax on the $40,000 gain. At the 15% federal capital gains rate, that’s a $6,000 tax bill. With step-up in basis through inheritance, the bill is zero. This benefit alone can save substantial amounts in taxes.
The step-up in basis applies automatically to assets inherited through your estate or through a revocable living trust. However, assets placed in certain irrevocable trusts during your lifetime may not receive step-up in basis, so planning is essential to maximize this benefit for your grandchildren.
Retirement Account Inheritance: The 10-Year Rule
Retirement accounts like IRAs and 401(k)s have their own complex rules for grandchildren. Most non-spousal beneficiaries must withdraw the entire balance within 10 years of the original owner’s death under the SECURE Act. This applies directly to grandchildren who inherit retirement accounts.
The 10-year clean-out rule means grandchildren must completely empty the inherited IRA by the end of the 10th year after the original owner’s death. The rule depends on when the original owner died. If the original IRA owner died before the date they were required to take distributions (the required minimum distribution start date), then grandchildren need not take annual distributions during those 10 years and can instead wait until year 10 to take all the money.
However, if the deceased IRA owner died after the start date for taking required distributions, annual distributions must be paid to the grandchild in years 1 through 9, with the rest of the account fully depleted by year 10. This creates potential tax complications because grandchildren must recognize this income when they withdraw it, pushing them into higher tax brackets.
Roth IRAs have a different rule: similar to Roth IRA owners, Roth IRA beneficiaries are not taxed on distributions. Additionally, because Roth IRA owners are not required to take distributions when alive, beneficiaries of inherited Roth IRAs need not worry about whether the original account owner died before or after the starting date for taking required distributions. A grandchild can opt to clean out the account in year 1, wait until year 10 to take out all the funds, or get annual distributions, as long as they fully deplete it within 10 years.
Minor grandchildren have additional protection: they can take required minimum distributions based on their life expectancy until they reach age 21, at which point the 10-year rule applies. This delay extends their time to withdraw the funds and can reduce their tax burden.
Three Scenarios: How Taxes Work in Real Situations
Scenario 1: Moderate Estate With No State Inheritance Tax
Margaret lives in Texas with a $5 million estate. She has two grandchildren and wants to leave them each $500,000. Margaret dies in 2025. Her $5 million estate is well below the $13.99 million federal exemption, so no federal estate tax applies. Texas has no state inheritance tax. Margaret’s grandchildren each inherit $500,000 tax-free.
| Situation | Amount |
|---|---|
| Margaret’s total estate | $5,000,000 |
| Federal exemption available | $13,990,000 |
| Situation | Amount |
|---|---|
| Taxable estate after exemption | $0 |
| Federal estate tax owed | $0 |
| Situation | Amount |
|---|---|
| State inheritance tax (Texas) | $0 |
| Amount each grandchild receives | $500,000 |
Margaret’s grandchildren pay zero tax because her estate is below the federal exemption and Texas has no state inheritance tax. The step-up in basis benefit applies to any appreciated assets in her estate.
Scenario 2: Large Estate With Federal Tax and State Tax
George lives in Pennsylvania with a $20 million estate. He has three grandchildren and leaves $5 million to each grandchild plus $5 million to his adult children. George dies in 2025. His $20 million estate exceeds the $13.99 million exemption by $6.01 million. Federal estate tax applies at 40% on the excess, which is $2,404,000. Pennsylvania inheritance tax applies at 4.5% to direct descendants like his grandchildren.
| Item | Amount |
|---|---|
| George’s total estate | $20,000,000 |
| Federal exemption | $13,990,000 |
| Item | Amount |
|---|---|
| Taxable amount for federal tax | $6,010,000 |
| Federal estate tax (40%) | $2,404,000 |
| Item | Amount |
|---|---|
| Each grandchild’s inheritance before PA tax | $5,000,000 |
| PA inheritance tax (4.5%) per grandchild | $225,000 |
| Item | Amount |
|---|---|
| Each grandchild’s net inheritance | $4,775,000 |
George’s estate pays $2,404,000 in federal estate tax. Then each of his three grandchildren pays Pennsylvania’s 4.5% tax on their $5 million inheritance, which is $225,000 per grandchild. The federal tax reduces the estate available for distribution.
Scenario 3: Direct Gift to Grandchild With Generation-Skipping Tax
Helen is 70 years old and has $15 million in assets. She wants to give $2 million to her grandchild Sarah right now during Helen’s lifetime. Helen has not used any of her lifetime gift and estate tax exemption. Helen makes a direct gift of $2 million to Sarah. This gift exceeds the $19,000 annual exclusion by $1,981,000.
| Component | Amount |
|---|---|
| Gift amount to Sarah | $2,000,000 |
| Annual gift tax exclusion (2025) | $19,000 |
| Component | Amount |
|---|---|
| Amount over annual exclusion | $1,981,000 |
| GST tax exemption allocation | $1,981,000 |
| Component | Amount |
|---|---|
| GST tax owed | $0 |
| Helen’s remaining GST exemption | $11,980,000 |
| Component | Amount |
|---|---|
| Sarah’s total received | $2,000,000 |
Helen must file Form 709 to report the gift, but she allocates $1,981,000 of her $13.99 million lifetime GST exemption to the transfer. Sarah receives the full $2 million with no tax. Helen still has $11,980,000 of her combined lifetime exemption remaining. Because Helen used her exemption wisely, Sarah paid zero tax.
Decoding the Tax Treatment of Different Asset Types
Different assets face different tax rules when passing to grandchildren. Cash is the simplest: your grandchildren inherit it tax-free (no income tax applies to inherited cash). They don’t owe federal estate tax if your total estate is below the exemption, and they don’t owe state inheritance tax in most cases. No step-up in basis applies to cash because it has no basis to step up.
Appreciated stock or real estate receives the huge benefit of step-up in basis. Your grandchild inherits at current market value, and any gain during your lifetime escapes income tax. If you bought real estate for $100,000 and it’s worth $400,000 when you die, your grandchild inherits it at $400,000 basis. They can sell it immediately for $400,000 with zero capital gains tax. This benefit alone justifies holding appreciated assets through your lifetime instead of gifting them early.
Traditional IRA or 401(k) funds inherited by grandchildren face income tax when withdrawn. Grandchildren must recognize this as ordinary income when they take distributions. If a grandchild inherits $100,000 in a traditional IRA and takes a $20,000 distribution, they must report $20,000 as ordinary income on their tax return, even though they received it from an inherited account. The 10-year rule forces them to eventually withdraw everything, creating years of ongoing income tax liability. Your estate paid estate tax on the IRA value, and your grandchild pays income tax on the distributions. This double taxation is substantial.
Roth IRA funds are tax-free to grandchildren, which is why Roth accounts are ideal for grandchildren. Your grandchild withdraws money with zero income tax, and the 10-year rule just requires complete distribution within 10 years (no annual distribution requirement). The estate pays no tax, and grandchildren pay no tax. This is the most tax-efficient way to leave retirement assets to grandchildren.
Life insurance proceeds are typically received income-tax-free by beneficiaries, but the death benefit is included in your taxable estate for estate tax purposes. If your $2 million life insurance policy is payable to your grandchild and your estate exceeds the exemption, the $2 million counts toward your taxable estate and triggers federal estate tax.
Critical Concepts: Income in Respect of a Decedent (IRD)
A hidden tax trap called income in respect of a decedent (IRD) affects retirement account inheritance significantly. IRD is income that the deceased was entitled to but hadn’t yet received at the time of death. It’s included in the deceased’s estate for estate tax purposes but not reported on their final income tax return.
The tax code provides that IRD is taxed when it’s distributed to the deceased’s beneficiaries, and IRD retains the character it would have had in the deceased’s hands. This means if an IRA would have been ordinary income to the deceased, it remains ordinary income to the grandchild. The lethal combination of estate and income taxes can quickly shrink an inheritance to a fraction of its original value.
Although IRD must be included in the income of the recipient, a deduction may come along with it that lessens the “double tax” impact. The IRD deduction is calculated by making a pro forma estate tax calculation to determine what estate tax would have been if none of the IRD were included in the taxable estate. The difference between actual estate tax paid and that pro forma calculation is the IRD deduction. Your grandchild can claim this deduction, but it only partially offsets the double taxation.
Tax Planning Strategies for Grandparents
Generation-Skipping Trusts provide the most comprehensive solution for grandchildren. A generation-skipping trust can allow trust assets to be distributed to grandchildren two or more generations younger than the donor without incurring GST tax. The trust can be structured with either discretionary distribution (allowing trustee flexibility) or mandatory distributions at specific ages or events.
A dynasty trust can preserve substantial amounts of wealth and potentially shelter it from federal gift, estate, and generation-skipping transfer taxes for generations to come. The advantage is that a dynasty trust avoids estate tax at each generational level. Without one, assets are taxed when passing from grandparent to parent and taxed again when passing from parent to grandchild. With a dynasty trust, the assets stay in the trust and skip the intermediate taxation.
Annual Gifting is simple but powerful. You can gift up to $19,000 per year to each of your grandchildren in 2025 without any gift tax or filing requirement. If you have five grandchildren, you can gift $95,000 per year ($19,000 × 5) completely tax-free. Over 10 years, you can move $950,000 out of your estate without using any of your lifetime exemption. This strategy is particularly valuable in years before the federal exemption drops in 2026.
A qualified personal residence trust (QPRT) allows you to transfer your home to grandchildren at a reduced gift tax value. You retain the right to live in the home during a specified term (typically 10-20 years). After the term ends, the home passes to your grandchildren. The gift tax is calculated based on the remainder value, which is much lower than the current home value. Any appreciation in the home’s value after the QPRT term passes to your grandchildren free of gift tax.
A Grantor Retained Annuity Trust (GRAT) is particularly suited for assets that are expected to appreciate, such as business interests or growth stocks. You place assets worth $1 million into a GRAT and retain the right to receive annuity payments for a specified term (often 2-10 years). Any appreciation above the IRS Section 7520 rate passes to your grandchildren tax-free. If your business interests are worth $1 million but grow to $3 million over the GRAT term, the $2 million appreciation goes to grandchildren with minimal or no gift tax.
You can contribute to a 529 education savings plan, and you can front-load five years of gifts (up to $95,000 for individuals or $190,000 for couples) into a 529 plan without triggering gift tax, as long as no additional gifts are made to the same beneficiary during that period. This removes the money from your taxable estate while funding your grandchildren’s education.
Mistakes to Avoid When Planning for Grandchildren
Mistake #1: Leaving Retirement Accounts to Grandchildren Without Tax Planning
Many grandparents assume their will controls where IRAs and 401(k)s go, but they don’t. Retirement accounts pass strictly by beneficiary designation, regardless of what is in your estate planning documents. Your grandchild is then hit with the 10-year rule and ordinary income tax on distributions. The better strategy is to leave IRAs to your spouse (if married), use Roth accounts if possible, or set up special trusts if IRAs must go to grandchildren.
Mistake #2: Not Updating Beneficiary Designations After Life Changes
When your grandchildren are born or when you marry or divorce, your IRA and life insurance beneficiary designations become outdated. If your old designation still names your ex-spouse as primary beneficiary, your grandchildren get nothing. IRA custodians will follow the beneficiary designation on file, regardless of what your will says. Review these designations every 3-5 years or after major life events.
Mistake #3: Gifting Appreciated Assets Without Understanding Basis Rules
When you gift appreciated stock or real estate to a grandchild during your lifetime, they inherit your low cost basis. If you bought stock for $10,000 that’s worth $50,000 and you gift it to a grandchild, they get a $10,000 basis. If they sell for $50,000, they owe capital gains tax on $40,000 gain. If that same grandchild inherits the stock when you die, they get a step-up to $50,000 basis and pay zero capital gains tax. Hold appreciated assets until death unless the gift tax savings outweigh the basis loss.
Mistake #4: Creating a Trust Without Generation-Skipping Tax Planning
If you create a trust for your children with instructions that remaining assets pass to grandchildren when children die, you’ve created what’s called a taxable termination. The assets are not taxed in your children’s estates but ARE subject to 40% GST tax when they pass to grandchildren. You must allocate your GST exemption to avoid this surprise tax. Many families face $500,000+ GST tax bills that could have been eliminated with proper planning.
Mistake #5: Ignoring the Federal Exemption Sunset in 2026
The federal estate and gift tax exemption is scheduled to drop from $13.99 million to approximately $7 million per person on January 1, 2026, unless Congress extends it. Grandparents with estates over $7 million should consider using their current higher exemption before year-end 2025. If you wait until 2026 and die after the sunset, much more of your estate will face the 40% federal tax.
Mistake #6: Holding Assets in Joint Tenancy With Grandchildren
Placing property in joint tenancy with a grandchild seems simple, but it creates tax and legal problems. The entire property value goes into your taxable estate when you die anyway. Your grandchild loses step-up in basis on your original basis portion. There’s also the risk of your grandchild’s creditors claiming the property, or divorce affecting the asset. Trusts are better for protecting property while you’re alive and for tax purposes at death.
Do’s and Don’ts: Practical Action Steps
| Action | Why It Matters |
|---|---|
| DO: Name retirement account beneficiaries directly | Retirement accounts don’t follow your will. They pass by designated beneficiary, giving you complete control. |
| DON’T: Make grandchildren joint tenants on real property | Joint tenancy avoids probate but creates tax inefficiency and loses step-up basis benefit on your portion. |
| DO: Use annual gifting of $19,000 yearly | Annual gifts remove assets from your taxable estate and are simple to execute with zero paperwork if under the limit. |
| DON’T: Gift appreciated assets during lifetime without planning | Gifting appreciated stock or real estate transfers your low cost basis to grandchildren, creating capital gains taxes when they sell. |
| DO: Place assets in trusts that have GST language | Trusts without proper GST language trigger 40% tax on generational transfers, costing hundreds of thousands unnecessarily. |
| DON’T: Leave traditional IRAs to grandchildren if possible | Traditional IRAs create immediate income tax liability, which compounds the estate tax grandparents already face. |
Pros and Cons: Different Inheritance Approaches
| Approach | Key Benefit | Key Drawback |
|---|---|---|
| Direct will inheritance | Simple to create; assets get step-up in basis; avoids probate with trusts. | All assets counted in taxable estate; no control over how beneficiaries use money. |
| Generation-skipping trust | Avoids GST tax on transfers to grandchildren; assets protected from creditors; controls distributions. | More expensive to create and manage; loses flexibility once trust is funded; may lose step-up basis. |
| Annual gifting | Removes assets from estate tax-free; simple execution; no filing if under annual limit. | Limited to $19,000 per grandchild per year; cannot be revoked once given away; reduces your liquidity. |
| Dynasty trust | Protects wealth across multiple generations; avoids estate tax at each level; provides creditor protection. | Most complex and expensive to set up; requires professional management; state-specific rules vary. |
| QPRT for real estate | Removes home value from estate; allows you to live there during term; appreciation passes tax-free. | Must survive term or home returns to estate; cannot easily modify terms once created. |
| Roth conversion strategy | Grandchildren inherit tax-free; no required distributions; maximum tax efficiency. | Grandparent pays income tax on conversion in year it occurs; requires planning and sufficient income. |
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| Approach | Key Benefit |
|---|---|
| Direct will inheritance | Simple to create; assets get step-up in basis; avoids probate with trusts. |
| Approach | Key Drawback |
|---|---|
| Direct will inheritance | All assets counted in taxable estate; no control over beneficiary use. |
| Approach | Key Benefit |
|---|---|
| Generation-skipping trust | Avoids GST tax on transfers to grandchildren; assets protected from creditors. |
| Approach | Key Drawback |
|---|---|
| Generation-skipping trust | More expensive to create and manage; loses flexibility once funded. |
| Approach | Key Benefit |
|---|---|
| Annual gifting | Removes assets from estate tax-free; simple execution; no filing if under limit. |
| Approach | Key Drawback |
|---|---|
| Annual gifting | Limited to $19,000 per grandchild per year; cannot be revoked once given. |
| Approach | Key Benefit |
|---|---|
| Dynasty trust | Protects wealth across multiple generations; avoids estate tax at each level. |
| Approach | Key Drawback |
|---|---|
| Dynasty trust | Most complex and expensive to set up; requires professional management. |
| Approach | Key Benefit |
|---|---|
| QPRT for real estate | Removes home value from estate; allows you to live there during term. |
| Approach | Key Drawback |
|---|---|
| QPRT for real estate | Must survive term or home returns to estate; cannot easily modify terms. |
| Approach | Key Benefit |
|---|---|
| Roth conversion strategy | Grandchildren inherit tax-free; no required distributions; maximum tax efficiency. |
| Approach | Key Drawback |
|---|---|
| Roth conversion strategy | Grandparent pays income tax on conversion; requires planning and sufficient income. |
Understanding Key Entities and Rules
The Executor is the person or institution you name in your will to carry out your instructions and distribute your estate. The executor pays estate taxes before distributing inheritance to grandchildren. Choosing the right executor is critical because they manage the tax process and timeline.
The Trustee is the person who manages a trust you create. For a generation-skipping trust for grandchildren, the trustee decides when to distribute assets, manages investments, and ensures proper tax reporting. A trustee can be a family member or a bank or trust company.
The Generation-Skipping Transfer Tax Exemption is your lifetime allowance of $13.99 million in 2025 that you can transfer to skip persons (grandchildren) without GST tax. This exemption must be allocated on tax returns, or it’s lost. Many families never allocate it, missing the opportunity to transfer billions to grandchildren tax-free.
The Annual Exclusion is the amount you can give to each person per year without filing or taxes. In 2025, it’s $19,000 per recipient. Married couples can combine to gift $38,000 per year to each grandchild. This amount can change annually based on inflation.
The IRS Section 7520 Rate is the federal interest rate used in valuation for trusts like GRATs and QPRTs. This rate changes monthly and determines how much appreciation passes tax-free to beneficiaries. It’s published by the IRS and often called the “hurdle rate.”
The Register of Wills is the county official responsible for probate administration in states like Maryland, Pennsylvania, and New Jersey. They collect inheritance taxes and oversee the distribution process.
State-Specific Planning: Important Differences
Texas has no state income tax, no state estate tax, and no state inheritance tax. Grandchildren in Texas inherit free of state taxes. However, they still face federal estate tax if your total estate exceeds $13.99 million. Texas also allows community property elections, which can provide additional step-up in basis benefits for married couples.
Pennsylvania taxes grandchildren at just 4.5% through inheritance tax if they receive assets. This is the lowest rate in Pennsylvania’s inheritance tax system. Pennsylvania also offers an exemption of $3,500 per grandchild for certain assets. The state Register of Wills collects this tax on behalf of the state.
New Jersey exempts grandchildren completely from inheritance tax. Any amount a grandchild inherits passes tax-free at the state level. However, New Jersey does impose its own estate tax on estates over $5.49 million (but the estate tax is paid by the estate, not grandchildren).
Maryland combines both estate tax and inheritance tax. Grandchildren are exempt from inheritance tax, but the estate itself faces state estate tax if over $5 million. This means the estate (not grandchildren) pays the tax, reducing what grandchildren inherit.
Nebraska taxes grandchildren at 1% on any inheritance over $100,000. This is very favorable compared to other states. There is no estate tax, only inheritance tax.
Kentucky completely exempts grandchildren from inheritance tax. No tax is owed at the state level when a grandchild inherits.
Florida, California, Texas, and most other states have no inheritance tax or estate tax at all. Grandchildren inherit tax-free at the state level in these states.
Common Misconceptions About Grandchild Inheritance
Misconception #1: “My grandchild will inherit my IRA tax-free”
This is false. Your grandchild will owe ordinary income tax on all distributions from an inherited traditional IRA. The fact that it’s inherited doesn’t change the tax treatment. They must withdraw everything within 10 years and pay tax as they withdraw it.
Misconception #2: “I can avoid gift tax by gifting under $15,000”
This is partially true but incomplete. You can gift $19,000 in 2025 without filing a gift tax return. But if you gift more, you file Form 709, though no tax is due unless you exceed your lifetime exemption of $13.99 million. The threshold for filing is different from the threshold for owing tax.
Misconception #3: “My will controls where everything goes”
This is false for assets with beneficiary designations. IRAs, 401(k)s, life insurance, and POD (payable-on-death) accounts pass by designated beneficiary. If your IRA beneficiary designation says your ex-spouse gets it but your will says grandchildren get it, your ex-spouse wins.
Misconception #4: “If my estate is under the federal exemption, I owe no taxes”
This is mostly true federally, but state taxes might still apply. If you live in Pennsylvania and leave $2 million to grandchildren, no federal tax applies, but Pennsylvania collects 4.5% state inheritance tax. You can also have a GST tax issue even if no federal estate tax applies.
Misconception #5: “There’s no federal inheritance tax, so my grandchildren pay nothing”
This is misleading. While there’s no federal inheritance tax, there IS a federal estate tax, federal GST tax, and federal income tax on inherited retirement accounts. Your grandchildren might face multiple layers of federal tax even though there’s no “inheritance tax” per se.
Required Forms and Processes When Someone Dies
When you die, your executor or trustee must file specific tax forms. [Form 706 is the federal](/estate tax return) estate tax return, filed only if the estate exceeds the exemption amount or if GST tax might be owed. [Form 709 is the gift](/tax return) tax return, filed if you make gifts exceeding the annual exclusion during lifetime or to allocate GST exemption. Form 709 must be filed even if no tax is owed, to preserve your GST exemption allocation.
[Form 1041 is filed for](/estate income) the deceased’s estate income if the estate generates income after death. Any interest, dividends, or rent earned by the estate after death is reported on Form 1041. Form 1040 is the final income tax return for the deceased, covering income earned up to the date of death.
State inheritance tax returns must be filed in the five states with inheritance taxes. In Pennsylvania, the state Register of Wills collects the inheritance tax. In Maryland, New Jersey, Nebraska, and Kentucky, state tax agencies collect these taxes. The timeline for filing varies by state, typically 9-18 months after death.
When a grandchild inherits a retirement account, they must file Form 8949 when they take distributions and report the income on their personal tax return (Schedule D for capital gains, or Schedule 1 for ordinary income).
FAQs
Do all grandchildren pay inheritance tax when they inherit?
No. Most grandchildren pay zero inheritance tax. Federal law has no inheritance tax. Only five states have inheritance taxes, and grandchildren are exempt in each. You must live in one of these five states for your grandchild to owe state inheritance tax.
Will my grandchildren have to pay federal estate tax on my inheritance?
Probably not. Your estate pays federal estate tax, not your grandchildren. Federal estate tax applies only if your total estate exceeds $13.99 million in 2025. Most families are below this threshold.
What is the generation-skipping transfer tax, and will my grandchildren pay it?
Yes, possibly. The GST tax is 40% on transfers to grandchildren that exceed your $13.99 million lifetime exemption. If you leave $15 million directly to a grandchild, the excess $1 million faces 40% tax. However, you can avoid it with proper planning.
Do inherited retirement accounts have special tax rules for grandchildren?
Yes, absolutely. Grandchildren who inherit traditional IRAs must withdraw and pay ordinary income tax on distributions within 10 years. This creates significant income tax liability that goes beyond estate tax.
Can I gift money to my grandchildren tax-free?
Yes. You can gift up to $19,000 per grandchild per year in 2025 without filing or owing taxes. Married couples can gift $38,000 per year per grandchild.
If my child dies before me, will my grandchildren still face the generation-skipping transfer tax?
No. When a grandchild’s parent dies before the grandparent, the grandchild moves up a generation. The GST tax no longer applies to transfers to that grandchild.
What is step-up in basis, and how does it help my grandchildren?
Step-up in basis resets the cost of inherited assets to their current value on your death date. Your grandchildren inherit appreciated assets at current value, avoiding capital gains tax on appreciation during your lifetime. This saves thousands or millions in taxes.
Should I hold appreciated assets until death or gift them to my grandchildren now?
Usually hold until death. Inherited assets get step-up in basis. Gifted assets keep your low cost basis, creating capital gains tax when your grandchild sells. Unless the gift tax exemption is about to expire, inherited is typically better for appreciated assets.
Can I leave my home directly to my grandchildren in my will?
Yes, but consider alternatives. Direct inheritance through a will works, but a QPRT (qualified personal residence trust) removes the home from your taxable estate while allowing you to live there. The QPRT can save substantial estate taxes.
What happens if my grandchildren inherit money from a trust instead of my will?
Tax treatment is usually the same. Trust distributions receive the same step-up in basis as will distributions if the trust is designed properly. However, some irrevocable trusts don’t provide step-up in basis. Work with an estate attorney to design the right trust structure.
Do my grandchildren inherit my capital gains on stocks when they inherit?
No, not with step-up in basis. Your grandchildren inherit the stock at its current market value on your death. They inherit with zero capital gains responsibility on the appreciation during your lifetime. This is one of the most valuable tax benefits in the entire tax code.
The tax landscape for grandchildren’s inheritance is complex because it involves multiple layers of federal and state rules. The federal government taxes your estate, some states tax your beneficiaries, the generation-skipping transfer tax can apply to direct transfers, retirement accounts have special income tax consequences, and capital gains treatments vary by asset type. Understanding these distinctions allows you to plan strategically, minimize unnecessary taxes, and ensure your grandchildren receive the maximum inheritance you intended to leave them. Taking action now, before the federal exemption drops in 2026, is critical for families with substantial assets.
Related reading
- Are You Really Taxed on an Inheritance? Avoid this Mistake + FAQs
- How Do GST Taxes Apply to Gifts for Grandchildren? + FAQs
- Are Gifts to Grandchildren Always Subject to GST Tax? + FAQs
- Who Pays Inheritance Tax on Gifts? + FAQs
- Does Inheritance Tax Apply to Children? + FAQs
- Can I Transfer My Premium Bonds to My Grandchildren? (w/Examples) + FAQs
- Is It Better to Inherit Money or Property? (w/Examples) + FAQs