Gifts, Estate Tax and Passing Wealth Across Generations

Most families will never owe federal estate tax, yet many make expensive choices because they think they will, such as giving away a rental property that would have passed far more cheaply at death. A smaller group does face the tax and has decades to reduce it, but only if they start early. This chapter explains how the federal gift and estate tax works in 2026, the gifts that never count against it, the step-up in basis that often matters more than the estate tax itself, and the trusts families use to pass wealth across several generations.

How the federal system works in 2026

The federal estate tax and gift tax are one system with one lifetime allowance. Each person can give away, during life and at death combined, up to the basic exclusion amount without paying tax: $15,000,000 for someone who dies in 2026. Above that, the rate is 40%.

The number moved recently. Before 2025 the exclusion was scheduled to fall by roughly half at the start of 2026. The 2025 tax law (Public Law 119-21) instead set it at the 2026 level and indexes it to inflation from 2027 on, with no scheduled end. Congress can still change it, so a plan built only around today's figure is a bet on future law.

Three features make the allowance go further than it looks.

The marital deduction. Anything left to a spouse who is a US citizen passes free of estate and gift tax, in any amount. The tax question arises when the second spouse dies.

Portability. When the first spouse dies, the executor can transfer that spouse's unused exclusion to the survivor by filing an estate tax return (Form 706), even if no tax is owed. With portability a married couple can shelter up to $30,000,000 in 2026. The election is lost if no return is filed, though the IRS allows a late election within five years of death in many cases. Filing for a modest estate feels like paperwork for nothing, but it can be worth a great deal if the survivor's assets grow or the law changes.

Charity. Bequests to charity are fully deductible from the estate. Chapter 4 covers the tax-smart ways to give.

If your spouse is not a US citizen, the unlimited marital deduction does not apply. Lifetime gifts to such a spouse are excluded only up to $194,000 a year in 2026, and a bequest needs a special trust called a qualified domestic trust to defer the tax.

The estate tax calculator shows whether an estate is over the line, by how much, and what portability changes.

State taxes are a separate layer. About a dozen states and the District of Columbia have their own estate tax, most with an exemption far below the federal one, and a handful charge an inheritance tax paid by the person who receives the money, at rates that depend on how closely related they are. Where you live and where you own property can matter more than the federal rules. Check your state revenue department's page.

Gifts that never use up the lifetime allowance

The annual exclusion. Each person can give up to $19,000 a year to as many people as they like, with no tax and no return to file. A married couple can give twice that to each recipient. A gift above the annual exclusion is not taxed either; it requires a gift tax return (Form 709) and reduces the lifetime allowance.

Tuition and medical bills paid directly. Payments made straight to a school for tuition or to a provider for medical care are excluded without limit, on top of the annual exclusion. Paying a grandchild's tuition directly to the university is a gift-tax-free transfer of any size; handing the grandchild the money first is not.

529 front-loading. A gift to a 529 college savings plan can be treated as spread over five years, so five years of annual exclusions can go in at once.

Annual gifts look small, but money given early grows outside the giver's estate.

A parent who gives $1,500 a month, a yearly total inside the annual exclusion, into an account invested at 6.0% puts in $324,000 over 18 years. The account ends near $571,439. The $247,439 of growth was never in the parent's estate and used none of the lifetime allowance. Keep in mind that money given to a child or into a custodial account is the child's, and chapter 7 discusses what that means.

Moving growth out early: the estate freeze

For the few who expect to be over the exclusion, the main idea is to give away assets that are likely to grow, so the growth happens outside the estate. Lawyers call this a freeze.

Give away an asset worth $1,000,000 today and it uses that much of the lifetime allowance. If it grows at 6.0% for 20 years it becomes about $3,207,135, and the $2,207,135 of growth is out of the estate. Kept until death, all of it would count. At 40%, that difference matters for an estate over the line and means nothing for one under it.

Common freeze tools include gifts to an irrevocable trust, a spousal lifetime access trust (an irrevocable trust for a spouse, which keeps indirect access to the money while the marriage lasts), a grantor retained annuity trust that passes only growth above an IRS interest rate, and family limited partnerships whose interests may be valued at a discount. These are technical, the IRS examines aggressive versions closely, and each needs an experienced attorney.

The step-up in basis: often the bigger number

When someone dies, most assets they owned outside retirement accounts get a new tax basis equal to their value at death. The heirs can sell right away and owe little or no capital gains tax on decades of growth. A gift during life does not get this: the recipient keeps the giver's original basis and owes the tax when they sell.

That changes the advice for most families. If an estate is well under the exclusion, giving away a stock bought decades ago, or adding a child's name to the deed of a house that has tripled in value, can turn a tax-free inheritance into a taxable sale. For estates under the line, the usual pattern is to keep low-basis assets until death and give cash or assets that have not grown much. For estates over the line, the 40% estate tax usually outweighs the long-term capital gains rate of 0%, 15% or 20%, so the trade-off reverses.

Three details matter. Traditional IRAs and 401(k)s never get a step-up; the heirs pay income tax as they withdraw. In the nine community property states, both halves of community property usually get a new basis when the first spouse dies, not just the half that belonged to the person who died. And the step-up works the other way for an asset worth less than its cost: the loss disappears at death, so selling it during life may be better.

Trusts that last for generations

A dynasty trust is an irrevocable trust meant to last for many generations. Most states once required trusts to end within a period tied to lives in being plus 21 years, the rule against perpetuities; several states, including South Dakota, Nevada, Delaware and Alaska, now allow trusts to last for centuries or indefinitely. Assets in a properly drafted dynasty trust are not taxed in each beneficiary's estate as generations pass, and a spendthrift clause usually keeps them out of reach of a beneficiary's creditors and, in many states, a divorcing spouse.

The tax that makes this work is the generation-skipping transfer (GST) tax, a second 40% tax on gifts that skip a generation, such as to grandchildren or a trust for them. Each person has a GST exemption, $15,000,000 in 2026, which can be allocated to a trust so that it, and all its future growth, stays exempt.

An irrevocable life insurance trust (ILIT) is a related tool. Life insurance on your life is counted in your estate if you own the policy. An ILIT owns it instead, so the death benefit passes outside the estate and can provide cash to pay estate tax or equalize an inheritance. A policy moved into an ILIT within three years of death is pulled back into the estate, so new policies are usually bought by the trust from the start.

The trade-offs of long-lived trusts: they are irrevocable, the trustee will make decisions for people not yet born, trust income kept in the trust is taxed at the top federal rate at a small fraction of the income at which an individual reaches it, and the costs run for decades. Many modern trusts add a trust protector with power to fix problems as laws change.