Estate and Gift Tax, and What Heirs Pay

The federal estate tax now reaches only a tiny share of families, so many people conclude that estate planning has nothing to do with tax. That is half right. The taxes that actually hit most heirs are income taxes: on the traditional retirement accounts they inherit, and on investments whose cost basis was handled badly. State estate and inheritance taxes start far lower than the federal one. And without a few basic documents, a family can lose time and money to court processes that have nothing to do with tax. This chapter covers the 2026 federal estate and gift tax, the income tax rules heirs face, state taxes, the trusts that matter and when, and the documents every adult should have.

The federal estate and gift tax in 2026

Federal estate and gift taxes share one lifetime exclusion. For deaths in 2026 it is $15,000,000 per person. Above it, the tax is 40%. The 2025 law set this amount without an expiry date and indexed it for inflation from 2027, so the cut that many older guides warned would end after 2025 did not happen. Congress can still change it.

Four rules decide whether an estate gets anywhere near the exclusion.

• The marital deduction. Everything left to a spouse who is a US citizen passes free of estate tax, in any amount. Gifts and bequests to a spouse who is not a citizen follow different rules, including a lower yearly gift limit and, for bequests, a qualified domestic trust.
• Portability. When the first spouse dies, the unused part of their exclusion can pass to the survivor, but only if the executor files an estate tax return (Form 706) to elect it, even when no tax is due. Families with no other reason to file often skip this and lose it.
• The annual gift exclusion. You can give up to $19,000 a year to each person, to as many people as you like, without filing a gift tax return or using any of your lifetime exclusion. A married couple can give twice that per recipient.
• Tuition and medical payments. Paying a school or a medical provider directly for someone else is excluded from gift tax in any amount, on top of the annual exclusion.

Larger gifts are not taxed either until your lifetime total passes the exclusion; you simply file a gift tax return and the gift reduces the exclusion left at death.

Two parents who each give one child $19,000 a year for 15 years hand over $570,000 without filing a gift tax return. Invested at 7.0% a year, the gifts grow to $985,165, and all of that growth happens outside the parents' estate. For families who may approach the exclusion, or who live in a state with a low estate tax threshold, steady annual gifts are the simplest planning tool there is. The estate tax calculator estimates the federal tax on an estate of your size, including portability.

State estate and inheritance taxes

About a dozen states and the District of Columbia charge their own estate tax, several with exemptions far below the federal one, and a handful charge an inheritance tax paid by the heirs, often depending on how closely they were related to the person who died. Where you live, and where you own real estate, can matter more than the federal rules. Check your state revenue department's current exemption before deciding that estate tax does not apply to you.

The income tax your heirs will face

Step-up in basis. Investments, a home or a business held until death get a new cost basis equal to their market value at death. The heirs can sell soon after and owe little or no capital gains tax; the gain during the owner's life is never taxed. Gifts made during life work differently: the recipient takes over the giver's original basis and pays tax on the full gain when they sell. That leads to a common rule of thumb: give cash or investments that have not grown much during life, and hold on to the most appreciated assets until death, unless the estate tax at 40% outweighs the capital gains saving. In community property states, both halves of a couple's community property usually get the step-up when the first spouse dies.

Inherited retirement accounts. Traditional IRAs and 401(k)s do not get a step-up. Every dollar is taxed as income to whoever withdraws it, which the IRS calls income in respect of a decedent. Most heirs who are not a spouse must empty an inherited account by the end of the tenth year after the death. Spouses, minor children of the owner (until 21), disabled or chronically ill heirs, and heirs not more than ten years younger than the owner can stretch withdrawals longer. If the owner had already started required distributions, a non-spouse heir must usually also take yearly distributions during the ten years.

An heir earning $90,000 owes $10,970. If equal yearly withdrawals from an inherited IRA raise income to $120,000, the tax becomes $17,570 in each of the ten years, with the top rate staying at 22.0%. Taking the same account in one year raises that year's income to $390,000 and the tax to $99,634, reaching the 35.0% bracket. Spreading the withdrawals keeps more of the account in the heir's family. For owners, this is one reason to consider Roth conversions in low-income years before death: an inherited Roth also must be emptied within ten years, but the withdrawals are tax-free.

Trusts: what each does, and for whom

A trust is a legal arrangement in which a trustee holds property for beneficiaries under written instructions. Most people need, at most, the first one on this list.

• Revocable living trust. You control it while you live and can change it. It avoids probate for the assets put into it, keeps the estate private and helps if you become unable to manage your affairs. It saves no tax: for tax purposes the assets are still yours.
• Irrevocable life insurance trust. Owns a life insurance policy so the payout is not counted in your estate. Useful for estates that would otherwise be taxable; a policy transferred into the trust is still counted if you die within three years.
• Qualified personal residence trust. Moves a home to heirs at a reduced gift value, provided you outlive the term you choose. Relevant mainly for large estates.
• Charitable remainder trust. You give appreciated assets to the trust, which can sell them without immediate capital gains tax and pay you an income for life or a term of years; the remainder goes to charity, and you get a partial deduction now.

Irrevocable trusts are hard to undo and usually need a lawyer to set up and a separate tax return each year. They make most sense when an estate is near the federal exclusion, faces a state estate tax, or needs to control how money reaches heirs.

Business owners should also have a buy-sell agreement that sets how an owner's share is valued and bought if they die or leave, usually funded with life insurance. A cross-purchase agreement, where the other owners buy the share, gives the buyers a higher cost basis than a redemption by the company, which matters if they later sell.

The documents every adult needs

Taxes aside, these do most of the work of an estate plan:

1. A will, naming who receives what, an executor and, for parents, a guardian for minor children.
2. Beneficiary designations on every retirement account, life insurance policy and transfer-on-death account. These override the will, so an outdated form can send money to an ex-spouse.
3. A durable financial power of attorney, so someone you trust can manage money if you cannot.
4. A health care directive and health care proxy, recording your wishes and who decides for you.

Review them after marriage, divorce, a birth, a death in the family or a move to another state.