Estate Tax Planning Guide: Federal Exemption, State Taxes & Strategies

How the Federal Estate Tax Works

The federal estate tax is a tax on the transfer of property at death. When someone dies, the IRS values their entire estate, including real estate, investments, business interests, life insurance proceeds, retirement accounts, and personal property. If the total value exceeds the federal exemption amount, the excess is taxed at a flat rate of 40%. The estate, not the heirs, is responsible for paying the tax before assets are distributed.

The estate tax applies to the fair market value of assets on the date of death (or an alternate valuation date six months later if the estate elects it). Debts, funeral expenses, administrative costs, and charitable bequests are deducted from the gross estate to arrive at the taxable estate. The unlimited marital deduction allows spouses to leave any amount to each other without estate tax, but this only defers the tax until the surviving spouse dies.

2026 Federal Estate Tax Exemption

For 2026, the federal estate tax exemption is $13.99 million per individual, or $27.98 million for a married couple. This means a single person can pass up to $13.99 million to heirs without any federal estate tax. This exemption was dramatically increased by the Tax Cuts and Jobs Act (TCJA) of 2017, which roughly doubled the pre-TCJA amount. However, the TCJA provisions are currently set to sunset, which could reduce the exemption to approximately $7 million per person (adjusted for inflation) if Congress does not extend or make permanent the higher amount.

This potential sunset creates urgency for high-net-worth families to act now. If your estate is between $7 million and $14 million, you could face zero estate tax under current law but significant tax liability if the exemption drops. Planning strategies like gifting and irrevocable trusts should be considered before any potential reduction takes effect. Use our Estate Tax Calculator to estimate your potential estate tax liability under different exemption scenarios.

The Gift Tax and Annual Exclusion

The gift tax and estate tax share a unified exemption. Taxable gifts made during your lifetime reduce your available estate tax exemption at death dollar-for-dollar. For 2026, the annual gift tax exclusion is $19,000 per recipient. This means you can give up to $19,000 to any number of people each year without using any of your lifetime exemption and without filing a gift tax return. A married couple can give $38,000 per recipient by splitting gifts.

Gifts above the annual exclusion require filing IRS Form 709 (Gift Tax Return) and reduce your lifetime exemption but do not trigger actual gift tax until you have exhausted the full $13.99 million exemption. Strategic annual gifting is one of the simplest estate reduction techniques. If you have three children and six grandchildren, a married couple can transfer $342,000 per year ($38,000 times 9 recipients) completely tax-free and without touching their lifetime exemption. Use our Gift Tax Calculator to model different gifting scenarios.

Portability: Sharing Exemptions Between Spouses

Portability allows a surviving spouse to use the deceased spouse's unused estate tax exemption (called the Deceased Spousal Unused Exclusion Amount, or DSUE). If a husband dies in 2026 with a $5 million estate, he uses only $5 million of his $13.99 million exemption, leaving $8.99 million unused. With a portability election, the surviving wife can add that $8.99 million to her own $13.99 million exemption, giving her a combined exemption of $22.98 million.

To elect portability, the executor of the first spouse's estate must file a federal estate tax return (Form 706) within nine months of death (with a six-month extension available), even if the estate is below the filing threshold. This is a critical step that many families miss. Without the Form 706 filing, the unused exemption is permanently lost. The IRS has granted relief in some cases through Revenue Procedure 2022-32, allowing a late portability election within five years of death, but relying on this relief is risky. Every married couple should consider portability election as part of their estate plan.

State Estate and Inheritance Taxes

Even if your estate is below the federal exemption, you may owe state estate or inheritance taxes. As of 2026, twelve states and the District of Columbia impose a state estate tax, and six states impose an inheritance tax. Maryland is the only state that imposes both. State exemption amounts are significantly lower than the federal exemption, typically ranging from $1 million to $6.58 million.

New York has a particularly aggressive "cliff" rule: if your taxable estate exceeds the exemption by more than 5%, the entire estate is taxed, not just the excess. An estate worth $7.29 million (exceeding the $6.94 million exemption by 5.04%) would owe tax on the full amount. This makes New York estate tax planning especially critical. Inheritance tax states (Iowa, Kentucky, Maryland, Nebraska, New Jersey, Pennsylvania) tax the recipients based on their relationship to the deceased, with close family members typically exempt or taxed at lower rates.

Trusts for Estate Tax Planning

Irrevocable Life Insurance Trust (ILIT)

Life insurance proceeds are included in your taxable estate if you own the policy. An ILIT removes the insurance from your estate by transferring ownership to an irrevocable trust. The trust owns the policy, pays the premiums (funded by your annual exclusion gifts), and distributes the death benefit to beneficiaries outside your estate. For someone with a $3 million life insurance policy in a $12 million estate, an ILIT could save $1.2 million in estate taxes (40% of $3 million). The policy must be transferred at least three years before death to be excluded from the estate, or the trust should purchase a new policy.

Grantor Retained Annuity Trust (GRAT)

A GRAT allows you to transfer appreciation on assets to heirs with minimal or zero gift tax. You transfer assets to the trust and receive fixed annuity payments over a set term. If the assets grow faster than the IRS assumed rate (the Section 7520 rate), the excess growth passes to beneficiaries gift-tax-free. A "zeroed-out" GRAT is structured so the annuity payments equal the initial gift value, resulting in no taxable gift. GRATs work best with assets expected to appreciate significantly, such as pre-IPO stock or a growing business interest.

Spousal Lifetime Access Trust (SLAT)

A SLAT is an irrevocable trust created by one spouse for the benefit of the other spouse (and potentially children and grandchildren). It removes assets from the grantor's estate while allowing indirect access through the beneficiary spouse. SLATs are popular for couples who want to take advantage of the current high exemption before a potential sunset but are concerned about losing access to the funds. Both spouses can create reciprocal SLATs, but they must be sufficiently different to avoid the reciprocal trust doctrine.

Qualified Personal Residence Trust (QPRT)

A QPRT transfers your home to an irrevocable trust while you retain the right to live in it for a specified term. At the end of the term, the home passes to your beneficiaries. The gift value for transfer tax purposes is discounted based on the retained interest, your age, and the term length. A $2 million home transferred through a 15-year QPRT by a 60-year-old might have a gift value of only $800,000, saving $480,000 in estate tax. The risk is that if you die during the trust term, the home is included back in your estate.

Advanced Gifting Strategies

Direct Payment of Tuition and Medical Expenses

Payments made directly to educational institutions for tuition or to medical providers for medical expenses are completely exempt from gift tax, with no dollar limit. These payments do not count against your annual exclusion or lifetime exemption. A grandparent can pay $50,000 in college tuition directly to the university and still give the grandchild an additional $19,000 annual exclusion gift in the same year. This is one of the most powerful and underused estate reduction strategies.

529 Plan Superfunding

You can front-load five years of annual exclusion gifts into a 529 education savings plan in a single year. For 2026, this means contributing up to $95,000 per beneficiary ($190,000 for a married couple splitting gifts). The contribution is treated as if it were made ratably over five years for gift tax purposes. This immediately removes the funds from your estate while providing tax-free growth for education expenses. If you die during the five-year period, a prorated portion is included back in your estate.

Family Limited Partnerships (FLPs)

An FLP allows you to transfer business or investment assets at a discounted value. You contribute assets to the partnership, retain a general partner interest (maintaining control), and gift limited partnership interests to family members. Limited partnership interests qualify for valuation discounts of 20-35% because they lack marketability and control. A $10 million portfolio in an FLP with a 30% discount could be valued at $7 million for gift tax purposes, saving $1.2 million in estate tax. However, the IRS scrutinizes FLPs closely, so they must have a legitimate business purpose beyond tax avoidance.

Stepped-Up Basis and Its Impact

When you inherit assets, their cost basis is "stepped up" to the fair market value on the date of death. If your parent bought stock for $100,000 that is worth $1 million at death, your basis becomes $1 million. If you sell immediately, you owe zero capital gains tax. This stepped-up basis is worth an enormous amount and should factor into estate planning decisions. Assets with large unrealized gains are often better left in the estate to receive the step-up rather than gifted during life (gifted assets retain the donor's original basis).

This creates a tension in estate planning: gifting reduces the taxable estate but forfeits the basis step-up, while holding assets until death preserves the step-up but keeps them in the estate. The optimal strategy depends on whether the estate will exceed the exemption and the magnitude of unrealized gains. For estates below the exemption, the step-up strategy is almost always superior. For estates well above the exemption, gifting appreciated assets may be better despite losing the step-up.

Estate Planning Checklist

Whether your estate is $2 million or $20 million, these steps form the foundation of a solid estate plan:

• Calculate your total estate value including life insurance, retirement accounts, and real estate
• Review your state's estate or inheritance tax rules and exemption thresholds
• Ensure your will and beneficiary designations are current and consistent
• Establish durable power of attorney and healthcare directive documents
• Consider portability election planning with your spouse
• Implement annual gifting using the $19,000 per-recipient exclusion
• Pay tuition and medical expenses directly to institutions for unlimited exclusion
• Evaluate whether an ILIT makes sense to exclude life insurance from your estate
• Review trust options (GRAT, SLAT, QPRT) for high-value assets
• Consult an estate planning attorney about the TCJA sunset impact on your plan

Use our Estate Tax Calculator to model your federal estate tax exposure under different exemption levels, and our Income Tax Calculator to understand how trust income distributions affect beneficiary tax brackets. For gift planning, our Gift Tax Calculator shows how gifts reduce your lifetime exemption and when Form 709 filing is required. Planning ahead with our Year-End Tax Planning Checklist ensures you do not miss critical deadlines.

Common Estate Tax Planning Mistakes

Failing to file Form 706 for portability is the most common and costliest mistake. When the first spouse dies with an estate well below the exemption, families assume no filing is needed. They forfeit millions in unused exemption that the surviving spouse could have used. Even if no tax is owed, filing Form 706 to elect portability should be automatic for every married couple.

Other frequent mistakes include owning life insurance personally instead of through an ILIT, failing to update beneficiary designations after divorce or remarriage, not accounting for state estate taxes (a $4 million estate owes nothing federally but could owe $200,000+ in Massachusetts or Oregon), gifting appreciated assets instead of holding them for the stepped-up basis, and waiting too long to implement strategies that require survival periods (the three-year rule for ILITs, the term requirement for QPRTs).

Frequently Asked Questions

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