How to Avoid Inheritance Tax: Gifts, Portability, and Trusts

To avoid inheritance tax, or at least shrink it as far as the law allows, you use the exemptions, exclusions, and trust structures already built into the tax code, and you put them in place well before death. For 2026, the federal estate tax exemption is $15 million per person and $30 million for a married couple, so most estates owe no federal tax at all.¹ The exposure that catches families off guard is usually at the state level, where thresholds can start as low as $1 million. The strategies below work against both, and every one of them rewards starting early.

Know Whether Federal Tax Even Applies to You

The $15 million per-person exclusion for 2026 comes from the One, Big, Beautiful Bill Act, signed on July 4, 2025, which amended the Internal Revenue Code and indexes the figure for inflation in future years.¹ Federal estate tax reaches everything you own or hold an interest in at death, valued at fair market value: cash, investments, real estate, business interests, life insurance, and retirement accounts.² After deductions for debts, administrative expenses, and transfers to a spouse or charity, whatever remains above the exemption is taxed at a top rate of 40%.

If your net worth is comfortably below $15 million and you don’t live in a state with its own death tax, federal planning is largely academic. If you’re near the line, or crossing it, the tools below are how you reduce what your heirs actually pay.

A Note on State Inheritance and Estate Taxes

Federal and state levies are separate systems, and the words matter. An estate tax is calculated on the total value of what the deceased owned. An inheritance tax is paid by the person receiving the assets, with the rate keyed to how closely related the recipient was to the deceased. Spouses are universally exempt; children and direct descendants are exempt or lightly taxed in most states that impose the tax; unrelated beneficiaries pay the highest rates.

Only five states impose a true inheritance tax, with rates running from 0% up to 16%. About a dozen states and the District of Columbia impose their own estate taxes, with exemptions as low as $1 million. One state imposes both. If a state tax applies to you, the federal strategies below still help, but you may also need state-specific planning around trust structure, lifetime gifts, or changing your domicile. This is where a local estate planning attorney is worth the fee.

Give Money Away Every Year

The simplest way to shrink a taxable estate is to move assets out of it while you’re alive. The annual gift tax exclusion lets you transfer up to $19,000 per recipient in 2026 without filing a gift tax return or touching your $15 million lifetime exemption.³ You can give that amount to as many people as you want. A married couple can combine exclusions and give $38,000 per recipient each year.⁴

One rule trips people up: the gift has to be a present interest, meaning the recipient can use or enjoy it right away. Handing a grandchild a check qualifies. Funding a trust the grandchild can’t touch until age 30 does not, unless the trust includes specific withdrawal rights. Gifts that fail the present-interest test won’t count toward the annual exclusion and will chip into your lifetime exemption instead.

If you give more than $19,000 to any one person in a year, file Form 709 to report the excess.⁵ Filing doesn’t necessarily mean you owe tax; the excess simply reduces your remaining lifetime exemption. Keep bank statements, copies of checks, and notes identifying each recipient and amount, because clean records prevent later arguments about whether transfers were gifts or loans.

Used year after year, this adds up fast. A couple with three children and six grandchildren can move $342,000 out of the estate every year without touching the lifetime exemption. Over a decade, that’s $3.4 million, plus whatever growth those assets generate in the recipients’ hands rather than in the estate.

Know When Not to Gift: The Stepped-Up Basis

Before you start giving everything away, understand what you give up. Under the stepped-up basis rule, when someone inherits property, the tax basis resets to fair market value on the date of death.⁶ If you bought stock for $50,000 and it’s worth $500,000 at your death, your heir’s basis becomes $500,000. They can sell the next day and owe zero capital gains tax on the $450,000 of appreciation.⁷

Gifts don’t get that treatment. They carry over your original basis. Give that same stock during your lifetime and your heir inherits your $50,000 basis; a later sale at $500,000 produces a $450,000 taxable gain, potentially costing more than $100,000 in federal and state capital gains taxes.

So the planning tension is this: the annual exclusion is ideal for cash and assets that haven’t appreciated much. For highly appreciated property, holding until death and letting your heirs get the step-up often beats gifting, especially when your estate is under the $15 million exemption and there’s no estate tax to avoid in the first place.

Two caveats. If someone gifts you appreciated property and you gift it back, and they die within a year, the step-up is disallowed on that property.⁶ And retirement accounts like IRAs and 401(k)s never get a step-up; distributions are taxed to the heir as ordinary income.

Use the Marital Deduction, and Elect Portability

Married couples have the most powerful shield in the code. You can leave any amount to your spouse with zero federal estate or gift tax, as long as the surviving spouse is a U.S. citizen.⁸ Assets held jointly with right of survivorship pass automatically. Retirement accounts and life insurance with the spouse as beneficiary qualify without extra paperwork. Watch for restrictive language in older wills or trusts that could limit the surviving spouse’s control, because conditions that prevent full ownership can disqualify the transfer.

If your spouse is not a U.S. citizen, the marital deduction does not apply.⁸ To defer the tax, you need a Qualified Domestic Trust (QDOT), which must have at least one U.S. citizen or domestic corporation as trustee, and the trustee must be able to withhold estate tax from any distribution of principal.⁹ Income distributions to the surviving spouse are free; principal distributions trigger the deferred tax. The non-citizen spouse can resolve the problem entirely by becoming a U.S. citizen before the estate tax return is filed.

Portability Is Not Automatic

The marital deduction defers tax; it doesn’t erase it. Whatever the surviving spouse owns at their own death, including what they inherited, is measured against their own exemption. Portability closes the gap: any unused portion of the first spouse’s $15 million exemption can transfer to the survivor, potentially giving them up to $30 million in combined exemption.

The mistake families make is assuming this happens by default. It does not. The executor of the first spouse’s estate must file a federal estate tax return (Form 706) and affirmatively elect portability, even when the estate is far too small to otherwise require a return. Miss that filing and the deceased spouse’s unused exemption is gone permanently. For a couple with a combined estate of $20 million, skipping the election can leave $5 million exposed at the survivor’s death. At 40%, that’s a $2 million cost caused by an unfiled form.

Keep Life Insurance Out of the Estate

Life insurance can quietly inflate a taxable estate. If you own a policy on your own life, the full death benefit counts as part of your gross estate, even though the money goes to your beneficiaries rather than through probate. The rule triggers whenever the deceased held any “incidents of ownership”: the right to change beneficiaries, borrow against the policy, surrender it for cash value, or assign it.¹⁰

An Irrevocable Life Insurance Trust (ILIT) removes the policy from your estate by having the trust own it instead of you. The trust buys the policy, pays the premiums, and distributes the proceeds after you die, all outside your taxable estate. An independent trustee, not you or your spouse, manages it, so the IRS can’t argue you retained control.

Moving an existing policy into an ILIT carries a critical trap: the three-year lookback. Transfer a policy to the trust and die within three years, and the IRS pulls the full death benefit back into your estate as if the transfer never happened.¹¹ The safer route is to have the trust purchase a new policy from day one, so the clock never starts.

ILITs demand ongoing discipline. Each time you contribute money to cover premiums, the trustee must send written notices (commonly called Crummey letters) to beneficiaries informing them of a temporary right to withdraw the funds. Those notices are what convert your contribution into a present-interest gift and qualify it for the annual gift tax exclusion. Skip them or send them late and the exclusion can be disallowed, potentially pulling the entire policy back into your estate. Setup legal fees typically run $1,000 to $10,000, but for estates where insurance proceeds would push the total over the exemption, the math strongly favors the trust.

Pay Tuition and Medical Bills Directly

One of the most underused tools is also one of the simplest. Any amount you pay directly to a school for tuition, or directly to a medical provider for care, is completely excluded from the gift tax with no dollar limit, no use of the annual exclusion, and no reduction of your lifetime exemption.⁴ A grandparent can write a $200,000 tuition check to a university and still give the same grandchild a $19,000 annual exclusion gift in the same year.

The one rule that matters is who receives the check. The payment must go to the institution, not to the student or patient. Give a grandchild $50,000 to pay their own tuition and it becomes a taxable gift subject to the annual exclusion cap. Write that $50,000 check directly to the university’s bursar and it’s fully excluded.

The tuition exclusion covers tuition only. Books, room and board, supplies, and activity fees don’t qualify. The medical exclusion is broader, covering payments for treatment, hospital stays, surgery, prescription medications, and health insurance premiums paid on someone else’s behalf.¹² Long-term care insurance premiums for an aging parent or in-law qualify too. Keep invoices and payment confirmations to document that funds went directly to the provider for a qualifying expense.

Use Charitable Trusts for Larger Estates

Charitable giving reduces a taxable estate dollar for dollar; every dollar that goes to a qualified nonprofit comes out before the tax is calculated.¹³ Outright bequests are the simplest way. Specialized trusts let you split the benefit between your family and a charity while cutting taxes more aggressively.

Charitable Remainder Trusts

A Charitable Remainder Trust (CRT) pays income to you or your family for a set period (up to 20 years, or for someone’s lifetime) and then passes what remains to a charity. You get an income tax deduction when the trust is funded, and the assets leave your taxable estate. Two variations exist:

A Charitable Remainder Annuity Trust (CRAT) pays a fixed dollar amount each year based on the trust’s initial value. The payout doesn’t change with investment performance, and you cannot add assets after creation.
A Charitable Remainder Unitrust (CRUT) pays a fixed percentage of the trust’s value recalculated annually. Payouts rise and fall with performance, and additional contributions are allowed.

Both must pay at least 5% but no more than 50% of the trust’s value each year, and the charity’s remainder interest must be worth at least 10% of the initial funding.¹⁴ Set the payout too high and the trust can be disqualified entirely, which is why the drafting requires professional actuarial work upfront.

Charitable Lead Trusts

A Charitable Lead Trust runs the other direction. The charity receives income from the trust for a set number of years, and the remaining assets then pass to your heirs. The gift tax value of what your heirs eventually receive is heavily discounted for the wait, which can sharply reduce transfer tax. The structure works best when interest rates are low, because the IRS’s assumed growth rate is modest and any excess actual growth passes to heirs tax-free.

Both types of charitable trust require careful drafting. The document must specify payout rates, duration, and charitable beneficiary. Non-cash assets going into the trust need professional appraisals to establish the correct deduction. For an estate that would exceed the $15 million exemption, these trusts do two jobs at once: they fund causes you care about and they lower what the IRS collects from your heirs.

1
Internal Revenue Service. What’s New — Estate and Gift Tax
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Internal Revenue Service. Estate Tax
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Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026, Including Amendments from the One, Big, Beautiful Bill
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Office of the Law Revision Counsel. 26 USC 2503 – Taxable Gifts
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Internal Revenue Service. Instructions for Form 709 (2025)
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Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired from a Decedent
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Internal Revenue Service. Gifts and Inheritances
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Office of the Law Revision Counsel. 26 USC 2056 – Bequests, Etc., to Surviving Spouse
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Office of the Law Revision Counsel. 26 USC 2056A – Qualified Domestic Trust
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Office of the Law Revision Counsel. 26 USC 2042 – Proceeds of Life Insurance
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Office of the Law Revision Counsel. 26 USC 2035 – Adjustments for Certain Gifts Made Within 3 Years of Decedent’s Death
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eCFR. 26 CFR 25.2503-6 – Exclusion for Certain Qualified Transfer for Tuition or Medical Expenses
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Office of the Law Revision Counsel. 26 USC 2055 – Transfers for Public, Charitable, and Religious Uses
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Office of the Law Revision Counsel. 26 USC 664 – Charitable Remainder Trusts