Estate Planning and Taxation: Federal, State, and Gift Tax Rules

Estate planning and taxation sit at the intersection of several different taxes, and for 2026 the headline number is this: the federal estate tax exemption is $15 million per person, so the vast majority of estates will never owe a dollar of federal estate tax.¹ But the federal estate tax is only part of the picture. State-level estate and inheritance taxes kick in at much lower thresholds in some places. Income taxes follow inherited retirement accounts. And a handful of elections and filings, if missed, can cost a family hundreds of thousands of dollars that straightforward planning would have saved.

What the Federal Estate Tax Actually Taxes

The federal estate tax applies when the value of what someone owned at death exceeds the exemption threshold.² The gross estate includes real estate, bank accounts, investment portfolios, business interests, and in some situations life insurance proceeds.³ Each asset is valued at its fair market value on the date of death, not what the owner originally paid.

From that gross figure, the estate deducts debts, funeral costs, charitable bequests, and anything passing to a surviving spouse. The result is the taxable estate. A unified credit shields the first $15 million from tax,⁴ and anything above that is taxed on a graduated scale that tops out at 40%.² The $15 million figure, set by Public Law 119-21 and signed on July 4, 2025, is permanent and indexed for future inflation.¹ A married couple can shelter up to $30 million combined when portability is properly elected.

The Marital Deduction and the Portability Election

Property left to a surviving spouse is fully deductible from the gross estate, with no dollar cap.⁵ One spouse can leave the entire estate to the other without triggering federal estate tax. The deduction only postpones the tax, though. When the surviving spouse dies, their estate is taxed on everything they own, including what they inherited.

Portability softens that. If the first spouse to die doesn’t use their full $15 million exemption, the survivor can claim what’s left and add it to their own.⁶ If the first spouse dies with a $4 million estate, $11 million of exemption carries over, and the surviving spouse can shield up to $26 million at their own death.

Portability is not automatic. The executor has to file Form 706, even if the first estate owes nothing. The standard deadline is nine months after death, with a six-month extension available. For estates small enough that no return would otherwise be required, a simplified procedure allows the portability election up to five years after death.⁶ Miss that deadline and the surviving spouse permanently loses access to the unused exemption. This is one of the most common and most expensive estate planning mistakes, and it usually happens because the family assumes a small estate doesn’t need to file anything.

Lifetime Gifts: Annual Exclusion and Unified Credit

The federal gift tax exists so people can’t simply give wealth away before death to escape the estate tax. Any transfer where you receive less than full value in return can be a taxable gift.⁷ Two exclusions keep ordinary generosity out of the system.

The annual exclusion lets you give up to $19,000 per recipient in 2026 without filing anything or touching your lifetime exemption.⁸ There’s no cap on the number of recipients. A parent with four children and eight grandchildren could move $228,000 in a single year with no tax consequences. A married couple can each give $19,000 to the same person, for a joint annual gift of $38,000 per recipient.

Above $19,000 to one person, you file Form 709, and the excess reduces your $15 million lifetime unified credit. No tax is actually owed until that lifetime amount is used up. Only after cumulative lifetime gifts exceed $15 million does the 40% rate apply.² Because the gift tax and estate tax share the same unified credit, every dollar used during life reduces what remains at death. Keeping accurate records of reportable gifts matters.

Direct Payments for Tuition and Medical Care

Payments for someone else’s tuition or medical expenses skip the gift tax system entirely, with no dollar limit, as long as you pay the institution or provider directly.⁹ A check to a university for a grandchild’s tuition is completely tax-free. A check to the grandchild, who then pays the university, is not. The tuition exclusion covers tuition only, not room and board or books. For medical care, qualifying payments include services from healthcare providers and health insurance premiums.

These payments don’t touch the annual or lifetime exclusions. You could pay $200,000 in tuition for a grandchild, give them another $19,000 as an annual exclusion gift, and owe nothing. For families with significant wealth, this is one of the cleanest ways to move money out of the taxable estate.

Generation-Skipping Transfer Tax

Transfers that go directly to grandchildren or more remote descendants trigger a separate tax on top of the regular estate or gift tax. The generation-skipping transfer tax was built to stop families from skipping a generation and avoiding one round of estate tax along the way.¹⁰

A “skip person” is anyone two or more generations below you. For family, that’s straightforward: grandchildren are skip persons, children are not.¹¹ A trust whose beneficiaries are all grandchildren or younger also counts as a skip person. The GST rate is a flat 40%, stacked on top of any estate or gift tax that already applies, so without planning a transfer to a grandchild can effectively be taxed twice.

The GST exemption matches the estate tax exemption at $15 million for 2026. You can allocate it to specific gifts or trusts and shield them from the 40% hit. Allocation is made on Form 709 for lifetime transfers or Form 706 at death. Getting the allocation wrong, or failing to make it, is where most GST problems start, and once a trust is funded without a proper allocation the fix is difficult and sometimes impossible.

Step-Up in Basis: The Biggest Break for Heirs

The federal estate tax grabs headlines, but the income tax treatment of inherited assets affects far more families. When you inherit property, the tax basis resets to its fair market value on the date of the prior owner’s death.¹² If a parent bought stock for $20,000 and it was worth $300,000 at death, your basis is $300,000. Sell it the next day at that price and your capital gain is zero. The step-up wipes out decades of unrealized appreciation in a single moment, and it is the single most valuable tax benefit in the inheritance system.

The step-up applies to real estate, stocks, mutual funds, and most other appreciated assets. In community property states, both halves of community property get a full basis adjustment when one spouse dies, not just the deceased spouse’s half.¹³ In a common-law state, only the deceased spouse’s share steps up. For jointly held real estate and investment accounts, that difference can save a surviving spouse tens of thousands of dollars in capital gains tax.

Inherited Retirement Accounts Are Different

Traditional IRAs, 401(k) plans, and similar tax-deferred retirement accounts don’t get a step-up. These accounts were funded with pre-tax dollars, so no income tax was ever paid on what’s inside. When a beneficiary withdraws from an inherited retirement account, the distributions are ordinary income at the beneficiary’s own rate.

For most non-spouse beneficiaries who inherited an account after 2019, the entire balance has to come out within ten years of the original owner’s death.¹⁴ If the original owner had already started required minimum distributions, the beneficiary also has to take annual withdrawals during that ten-year window rather than waiting until the end. Missing those annual distributions can trigger a penalty of up to 25% of what should have been withdrawn. Spouses, minor children, disabled individuals, and beneficiaries less than ten years younger than the deceased have more flexibility and can often stretch distributions over their own life expectancy.

A $1 million inherited IRA drained in ten years can push $100,000 or more in annual distributions into high tax brackets. Timing withdrawals strategically across the window, rather than taking a lump sum, usually produces a better after-tax result.

Trusts Used to Reduce Estate Taxes

For estates large enough to face federal or state tax, several irrevocable trusts can move assets out of the taxable estate while preserving some benefit for the person creating them. Each works differently and carries its own trade-offs.

Irrevocable Life Insurance Trusts

Life insurance proceeds are pulled into your gross estate if the policy is paid to your estate or if you held ownership rights in it.¹⁵ A $5 million policy can push an otherwise exempt estate over the $15 million line. An irrevocable life insurance trust owns the policy instead of you, so the death benefit stays outside your taxable estate.

The price of admission is giving up all control. You can’t serve as trustee, change beneficiaries, or cancel the policy. If you transfer an existing policy into the trust and die within three years, the proceeds get pulled back into your estate as if the transfer never happened. A new policy bought directly by the trust avoids that three-year lookback.

Grantor Retained Annuity Trusts

A grantor retained annuity trust holds appreciating assets while paying you fixed annual amounts for a set term. If the trust’s investments outperform the IRS hurdle rate, the excess growth passes to your beneficiaries free of gift and estate tax. A “zeroed-out” GRAT structures the annuity payments to roughly equal the original contribution, so little or none of your lifetime exemption is consumed.

The risk is simple: if you die during the term, the entire value snaps back into your taxable estate. GRATs tend to work best for younger grantors with assets expected to appreciate significantly. If the investments lag the hurdle rate, you get your assets back and lose only the legal and administrative costs.

Qualified Personal Residence Trusts

A qualified personal residence trust transfers your home into an irrevocable trust while you keep the right to live there for a specified number of years. Because of that retained interest, the taxable value of the gift is discounted, so the transfer uses less of your lifetime exemption than an outright gift of the same house. Appreciation during the term also passes to beneficiaries free of additional tax.

You have to outlive the term. If you die before it ends, the home comes back into your taxable estate at full value and the planning benefit vanishes. Once the term is over, you no longer own the home and have to pay fair market rent to keep living there. QPRTs tend to fit people in their 50s or 60s with a home they intend to keep for a defined stretch.

Charitable Lead and Remainder Trusts

A charitable lead trust pays income to a charity for a set term and then distributes the remaining assets to your family. The charitable payments can generate an income tax deduction, and the eventual transfer to family can be structured to minimize or eliminate gift and estate taxes. The structure works especially well in low-interest-rate environments, when the IRS discounts the remainder interest more heavily.

A charitable remainder trust runs the other way. You or your family receive income from the trust for a term of years or for life, and the charity gets what’s left. The assets leave your estate, and you keep an income stream during your lifetime. Both types need careful structuring, and the IRS looks closely at the actuarial calculations.

State Estate and Inheritance Taxes

The federal exemption shelters almost everyone, but several states impose their own death taxes at much lower thresholds. Some start taxing estates at $1 million. Your estate can owe nothing to the IRS and still face a meaningful state bill. The rules and rates vary widely, and the state where you live at death matters a great deal.

State death taxes come in two forms. An estate tax is assessed against the total estate value before anything is distributed, like the federal version. An inheritance tax is owed by each beneficiary based on what they personally receive, with the rate depending on their relationship to the deceased. Spouses and children typically pay little or nothing; more distant relatives and unrelated beneficiaries pay more. A few states impose both.

Top state rates run as high as 16% to 20%, though most beneficiaries pay well below that, and close family members often qualify for full exemptions or reduced rates. Because state exemptions sit so far below the federal line, these taxes are a concern for families who would never trigger federal tax. For people who split time between states, establishing clear domicile in a state without a death tax is one of the simplest and most effective planning moves available.

1
Internal Revenue Service. What’s New — Estate and Gift Tax
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Office of the Law Revision Counsel. 26 US Code 2001 – Imposition and Rate of Tax
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Office of the Law Revision Counsel. 26 USC 2031 – Definition of Gross Estate
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Office of the Law Revision Counsel. 26 US Code 2010 – Unified Credit Against Estate Tax
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Office of the Law Revision Counsel. 26 USC 2056 – Bequests to Surviving Spouse
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Internal Revenue Service. Frequently Asked Questions on Estate Taxes
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Office of the Law Revision Counsel. 26 US Code 2501 – Imposition of Tax
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Internal Revenue Service. Frequently Asked Questions on Gift Taxes
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Office of the Law Revision Counsel. 26 USC 2503 – Taxable Gifts
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Office of the Law Revision Counsel. 26 USC 2601 – Tax Imposed
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Office of the Law Revision Counsel. 26 USC 2613 – Skip Person and Non-Skip Person Defined
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Office of the Law Revision Counsel. 26 US Code 1014 – Basis of Property Acquired From a Decedent
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Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent
14
Internal Revenue Service. Retirement Topics – Beneficiary
15
Office of the Law Revision Counsel. 26 USC 2042 – Proceeds of Life Insurance