As Congress wrangles with the federal estate tax exemption rules, it may be an opportune time to highlight the financial threat of estate taxes in general. The federal government, and a handful of states, assess an estate tax on the value of a deceased person’s taxable estate once it rises above a certain threshold. While we cannot provide specific legal advice and recommend consulting with an estate planning attorney, this article will review the basic concepts of some strategies for potentially reducing the amount of your taxable estate.
In general, when a person dies, anything that they own or have control over is considered “theirs” when figuring the amount of net assets to be included in the taxable estate. The calculation uses the fair market value at the date of death and not a purchase price or the value whenever an asset was acquired. Almost any asset that is titled in an individual’s name, such as real estate, bank accounts, investment accounts, and vehicles to name a few, is usually included in this calculation of a person’s total estate.
The current federal estate tax exemption is $13.99 million, meaning you can transfer up to that amount to heirs over the course of your lifetime without being subjected to any federal estate taxes. Spouses are able to combine their federal exemption, so a couple can theoretically give nearly $28 million without paying any estate taxes to the federal government. However, this exemption figure has been as low as $675,000 earlier in this millennium, so a lot can change in Washington regarding how estates are taxed in the future. If you have more assets to your name than the exclusion amount, the additional value is taxed at an escalating scale, with the highest federal applicable rate being 40%.
While the federal government exemption is currently high, several states assess their own estate tax on residents’ taxable estates and usually offer exemption amounts much lower than the federal one. For example, Illinois only exempts the first $4 million and Oregon taxes all estate value above $1 million per person. For those living in states with no estate tax, the federal exemption amount is all they need to worry about but, in states with their own estate tax, additional planning maybe required.
A basic way to reduce your taxable estate is through annual gifting to family members. Each year, the IRS sets an amount that you can gift to anyone without having to report it on a gift tax return or have it count against the lifetime exemption amount described above. For 2025, this is $19,000 per giver, so a married couple could transfer $38,000 to as many individual recipients as they wish. When you count children, their spouses, and grandchildren, the amount of available annual tax-free gifting can be quite large. Anyone can gift more than this amount in a given year, but then a gift tax return must be filed. No taxes are owed immediately but the amount gifted above and beyond the annual exclusion amount would reduce the available lifetime exemption amount (i.e. $13.99 million) available to the donor.
Since there are no restrictions on the usage of a direct gift (i.e. writing a check or donating stock to a recipient), the entire amount of these gifts is immediately removed from the taxable estate of the giver. Giving appreciated stock instead of cash can have the double benefit of lowering your taxable estate while also letting the recipient potentially pay less in capital gains taxes, if they are in a lower bracket. If the donor would have paid 20% or 23.8% in capital gain taxes on the profit from selling an investment but a recipient can pay either 0% or 15% (depending on their income), the $19,000 of stock may be worth even more to the recipient, after considering taxes, than it is to the giver.
If funding education for grandchildren is in your financial plans, you can also take advantage of an IRS rule to amplify your annual gifting and immediately remove a large chunk of assets from your estate. When funding a 529 plan, you can give five years’ worth of the annual gift exclusion (5 * $19,000 = $95,000) and have the entire gift removed from your estate while letting the large initial gift count as five separate years of making the maximum annual exclusion gift for tax reporting purposes. For example, if seeding a 529 plan with $95,000 in 2025, the entire gift is removed from your estate now and you would take a $19,000 gift exclusion on your 2025-2029 tax returns so the amount would not count against any lifetime exemption amounts. A married couple can double this amount, so that an immediate gift of $190,000 would come out of the estate without any reduction in the lifetime exemption amount.
There are myriad ways to include charitable gifting wishes in an estate plan but, in general, any amount gifted to a charitable organization is removed from the donor’s taxable estate. This can take the form of donor advised fund (DAF) contributions or one of several types of charitable trusts that are beyond the scope of this article. Because gifts to charitable trusts are irrevocable, the amount is removed from the donor’s taxable estate, even if the donor’s family or beneficiaries may receive income from the trust in the future.
Another strategy to touch on is the irrevocable life insurance trust (ILIT). Similar to a charitable trust, the ILIT is irrevocable and thus assets owned by the trust are not included in the taxable estate of the person funding the trust. In this case, the ILIT would eventually be a recipient of a large death benefit from an insurance policy that would not be included in the deceased person’s taxable estate. How the ILIT typically works is that the ILIT would own a life insurance policy on the person setting it up—typically in the several million-dollar range—and then would receive gifts into the trust each year from the donor to pay the premium on the life insurance. As long as the trust is receiving less than the annual gift exclusion amount ($19,000) times the number of beneficiaries of the trust (i.e. $38,000 for two beneficiaries) each year, there is no gift tax reporting or effect on the lifetime exemption amount of the person making the gifts. One caveat for the ILIT gifts is that, for the annual premium payment gift to count as a “completed gift” and thus qualify for the annual exclusion, the beneficiaries of the trust must receive what are known as Crummey letters notifying them of the right to withdraw the funds gifted to the ILIT within a 30-day period (beneficiaries will typically not exercise this right or there would not be enough funding to keep the insurance policy in place). As long as the insured dies while the life insurance policy is in force, the beneficiaries receive the large death benefit without it counting as part of the deceased’s taxable estate.
Reducing your taxable estate is a bit of a moot point if you are not already secure with your own financial future and plan. While no one likes to pay more taxes than they need to, making sure you are set up for a comfortable retirement should be prioritized over some of these strategies that may reduce the amount of assets available to you. Once you are confident in not needing the entire portfolio to live on, however, enacting some of these strategies can help reduce your potential estate tax liability down the road. Please contact us if you would like to discuss any of these strategies in more detail.
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