What Is Estate Tax: Thresholds, Exemptions, and How to Plan Around It

What Is the Estate Tax?

The estate tax is a federal tax levied on the total value of a deceased person's taxable estate before assets are distributed to heirs. It is sometimes called the "death tax" in political discourse, though that term is not used in the Internal Revenue Code. The estate tax is assessed on the estate itself — not on the individuals who receive the inheritance — which distinguishes it from inheritance taxes, which are levied on the recipients. The federal estate tax has existed in various forms since 1916, originally enacted as a temporary measure to raise revenue during World War I preparation.

For 2025, the federal estate tax applies only to estates exceeding the basic exclusion amount of $13.99 million per individual ($27.98 million for married couples using portability). This extremely high threshold means that only a tiny fraction of estates — less than 0.2 percent of deaths annually — are subject to any federal estate tax. However, the threshold is scheduled to sunset at the end of 2025 under current law, potentially reverting to approximately half its current level (adjusted for inflation from the pre-TCJA baseline), which would bring significantly more estates into taxable territory if Congress does not act.

How the Federal Estate Tax Is Calculated

The gross estate includes essentially everything the decedent owned at death: real estate, financial accounts and investments, business interests, life insurance proceeds (if the decedent owned the policy), retirement accounts, personal property including vehicles and collectibles, and their share of jointly owned property. Gross estate also includes certain transfers made within three years of death and the value of any revocable trusts the decedent controlled.

From the gross estate, deductions are subtracted to arrive at the taxable estate. Major deductions include the marital deduction (which allows an unlimited deduction for assets passing to a surviving U.S. citizen spouse, deferring all estate tax to the second spouse's death), the charitable deduction (assets passing to qualifying charities are fully deductible), funeral and administrative expenses, and debts of the estate. After these deductions, the basic exclusion amount is applied. The amount exceeding the exclusion is taxed at a top rate of 40 percent, with lower rates applying to amounts within smaller ranges above the exemption.

The unified credit structure means that any portion of the basic exclusion used for taxable gifts during life reduces the exclusion available at death. The estate tax and the gift tax are unified — they share a single lifetime exclusion — which prevents simple avoidance by giving everything away before death. Annual exclusion gifts of up to $19,000 per recipient per year (2025) are exempt from this unified system and do not reduce the lifetime exclusion, making annual gifting one of the most accessible estate-reduction strategies for families with significant wealth.

State Estate and Inheritance Taxes

Many states impose their own estate or inheritance taxes, often with much lower exemption thresholds than the federal system. Twelve states and the District of Columbia impose estate taxes with exemptions ranging from $1 million (Massachusetts, Oregon) to the federal level (Connecticut, Hawaii). Estates that fall below the federal exemption may still owe state estate tax in these jurisdictions, making state-level planning critical even for many middle-wealth families.

Six states — Iowa (being phased out), Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania — impose inheritance taxes rather than estate taxes. Inheritance taxes are paid by the beneficiary based on the amount they receive, with rates and exemptions that typically vary by the relationship between the decedent and the beneficiary. Spouses are typically exempt, and close family members (children, grandchildren) often face lower rates or exemptions, while more distant relatives and unrelated beneficiaries pay higher rates. Maryland imposes both a state estate tax and an inheritance tax — a double burden on taxable transfers.

Portability: Doubling the Married Couple Exemption

One of the most significant estate planning simplifications introduced in 2010 is portability — the ability of a surviving spouse to use the deceased spouse's unused estate tax exemption (DSUE). If the first spouse to die has a $13.99 million exemption but only $3 million in assets, the surviving spouse can elect to carry over $10.99 million of unused exemption. Combined with their own $13.99 million exemption, this gives the surviving spouse up to approximately $24.98 million of total exemption — significantly more than the $27.98 million available from a married couple using portability at current levels.

However, portability must be elected on a timely filed estate tax return (Form 706) even if no estate tax is due. Many surviving spouses fail to file this return because they believe no filing obligation exists when the estate is under the threshold, unintentionally forfeiting the portability election. Estate attorneys universally recommend filing a portability election return as standard practice when the first spouse dies, even for modest estates, because the protection it provides against future estate tax exposure if the surviving spouse's estate grows is inexpensive insurance.

Common Estate Tax Reduction Strategies

For estates that approach or exceed the exemption threshold, a range of planning tools can reduce estate tax exposure. Irrevocable life insurance trusts (ILITs) remove life insurance proceeds from the taxable estate — if the trust owns the policy rather than the insured, the death benefit passes to heirs estate-tax-free, often providing liquidity specifically to pay other estate taxes or equalize inheritances among beneficiaries who receive illiquid assets like a family business.

Grantor retained annuity trusts (GRATs) allow a taxpayer to transfer appreciation in assets to heirs with minimal gift tax cost. The taxpayer places assets in the GRAT and receives annuity payments back for a fixed term; at the end of the term, any remaining value (essentially the excess return above the IRS hurdle rate, currently based on the 7520 rate) passes to heirs free of gift tax. In a low-interest-rate environment or when high-growth assets are contributed, GRATs can transfer substantial wealth at minimal tax cost. Intentionally defective grantor trusts (IDGTs), qualified personal residence trusts (QPRTs), and charitable lead trusts (CLTs) are additional tools used by estate planning attorneys for specific circumstances.

Family limited partnerships (FLPs) and family limited liability companies (FLLCs) allow the bundling of family assets into an entity with senior (general partner or managing member) and junior (limited partner or non-managing member) interests. Transfers of limited or minority interests qualify for valuation discounts — typically 15–35 percent — reflecting the lack of control and lack of marketability of those interests. If a taxable estate includes $10 million of FLP limited interests, valuation discounts might reduce the taxable value to $7 million, saving as much as $1.2 million in estate taxes at the 40 percent rate. The IRS scrutinizes these arrangements closely for substance, requiring that FLPs serve legitimate non-tax purposes and that proper formalities be maintained.

The Sunset Issue and Planning Urgency

The current high exclusion amounts under the Tax Cuts and Jobs Act expire at the end of 2025, unless Congress passes new legislation. If the sunset occurs, the exemption will revert to approximately $7 million per person (adjusted for inflation), bringing many more estates into taxable territory. The IRS has confirmed through published guidance that gifts made under the current high exemption will not be "clawed back" if the exemption later decreases — meaning taxpayers who make large gifts before the sunset can lock in the tax-free transfer permanently.

This sunset creates a specific planning window for families whose combined wealth exceeds $14 million (the expected post-sunset exemption for married couples). Using the current $27.98 million joint exemption before year-end 2025 by making large irrevocable gifts to trusts or directly to family members can permanently remove those assets from the taxable estate, regardless of what happens to the exemption amount in subsequent years. Estate planners are strongly advising wealthy clients to accelerate gifting strategies in advance of the potential sunset, making 2025 a critical year for estate planning action.