Federal estate tax applies only to estates larger than a threshold that changes yearly

Federal estate tax is a tax on the total value of everything a person owns when they die — their house, investments, retirement accounts, life insurance, and personal property. The IRS taxes the estate itself, not the heirs who inherit it, though the tax reduces what's left to distribute.

The key number is the federal estate tax exemption. In 2024, you can leave up to $13.61 million to heirs without owing any federal estate tax. If your estate exceeds that amount, the IRS taxes the overage at 40 percent. For a married couple, both spouses can use their own exemption, potentially sheltering $27.22 million combined.

This exemption is temporary. It is scheduled to drop to roughly $7 million per person (adjusted for inflation) on January 1, 2026, unless Congress extends it. That change affects planning now if you have a large estate or expect to receive a large inheritance.

Key Takeaways

  • Federal estate tax only applies to estates worth more than $13.61 million in 2024, so most people never owe it.
  • The exemption drops to around $7 million per person in 2026 unless Congress acts, which changes the urgency of planning for larger estates.
  • Some states impose their own estate or inheritance taxes with much lower thresholds, sometimes as low as $1 million.
  • Married couples can combine exemptions and use strategies like portability elections and trusts to shelter more wealth from tax.
  • Life insurance proceeds are included in your taxable estate unless the policy is owned by an irrevocable trust or another person.

State estate and inheritance taxes hit smaller estates

Seventeen states and the District of Columbia impose their own estate or inheritance taxes, and their thresholds are much lower than the federal level. New Jersey, for example, taxes estates over $675,000. Massachusetts taxes estates over $1 million. Connecticut taxes estates over $12.92 million but uses a different rate structure than federal tax.

The difference between an estate tax and an inheritance tax matters for planning. An estate tax is paid by the estate before distribution to heirs. An inheritance tax is paid by the person who receives the inheritance, though rates often depend on their relationship to the deceased — spouses and children usually pay less or nothing, while distant relatives or non-relatives pay more.

If you live in or own property in a state with an estate tax, you may owe state tax even if you don't owe federal tax. A resident of Massachusetts with a $2 million estate owes no federal estate tax but does owe Massachusetts estate tax. This is one reason to review your state's rules if you have significant assets.

Married couples can use portability to double their exemption

When the first spouse dies, the surviving spouse can elect portability, which allows them to use any unused portion of the deceased spouse's exemption in addition to their own. This is done by filing Form 706 (the federal estate tax return) even if the estate is small enough that no tax is owed.

Portability is valuable because it lets a married couple shelter twice the exemption amount without setting up a trust. A couple with $20 million in assets can structure their plan so the first spouse to die uses their $13.61 million exemption, and the surviving spouse can then use both their own exemption and the deceased spouse's unused portion.

The catch is that portability must be elected within nine months of death (or longer if you file for an extension). If the executor doesn't file Form 706 and make the election, the unused exemption is lost forever. This is a common and costly mistake, so it's worth flagging to your executor or trustee before you die.

Life insurance and retirement accounts are included in your taxable estate

Many people assume life insurance proceeds pass to beneficiaries tax-free, and they do — but the proceeds are still counted as part of your taxable estate for federal estate tax purposes. If you have a $5 million life insurance policy and $10 million in other assets, your taxable estate is $15 million, not $10 million.

The same applies to retirement accounts like IRAs and 401(k)s. The balance at your death is included in your taxable estate. This can create a surprise for families with large retirement accounts or life insurance who thought they were below the exemption threshold.

One strategy is to own life insurance through an irrevocable life insurance trust (ILIT). If the trust owns the policy rather than you, the proceeds are not included in your taxable estate. This requires giving up ownership of the policy, so it's typically done years before death. A tax professional can help you decide whether an ILIT makes sense for your situation.

Timing gifts and bequests can reduce estate tax exposure

You can give away money or assets during your lifetime without owing gift tax, up to an annual limit. In 2024, you can give up to $18,000 per person per year without using any of your lifetime exemption. A married couple can give $36,000 per recipient per year.

Gifts above that annual limit do use your lifetime exemption, but they don't trigger a tax — they just reduce the exemption available at death. If you give away $100,000 to a child in 2024, you've used $82,000 of your exemption (the $100,000 minus the $18,000 annual exclusion). Your exemption at death would then be $13.61 million minus $82,000.

For people with estates close to the exemption threshold, or those concerned about the 2026 drop, making gifts now can be a way to move assets out of your taxable estate while the exemption is still high. This is especially useful if you expect the assets to grow — the growth happens outside your estate.

Trusts can shelter assets and provide other benefits beyond tax savings

A revocable living trust does not reduce your taxable estate — you still own the assets, so they're still taxed at your death. But it does avoid probate and keeps your affairs private, which many people value for reasons unrelated to taxes.

An irrevocable trust can reduce your taxable estate because you give up ownership of the assets placed in it. Assets in an irrevocable trust are not included in your estate at death, so they're not subject to estate tax. The trade-off is that you lose control of the assets and cannot change the trust terms later.

Common irrevocable trusts include may have access to personal residence trusts (QPRTs), which let you live in your home for a set period before it passes to heirs at a reduced tax value, and charitable remainder trusts, which provide income to you during your lifetime and then pass assets to charity. These are complex strategies that require professional help to set up correctly.

The 2026 exemption cliff creates planning decisions now

Because the federal exemption is scheduled to drop in 2026, people with large estates face a choice: act now while the exemption is high, or wait and see if Congress extends it. There is no perfect answer, and the right choice depends on your age, health, family situation, and how certain you are about the value of your estate.

Some people use a strategy called exemption-leveraging, where they make large gifts now using their current high exemption, locking in the tax value at today's levels. Others set up trusts that are designed to benefit from the higher exemption if they're funded before 2026. These decisions are not reversible, so they warrant a conversation with an estate planning attorney and a tax professional.

If you have an estate over $7 million, or if you expect to have one by 2026, it's worth reviewing your plan with a professional sooner rather than later. The cost of planning now is usually far less than the tax bill if you don't plan.

Frequently Asked Questions

Do I owe estate tax if I leave everything to my spouse?

No. The marital deduction allows you to leave an unlimited amount to your spouse without owing any federal estate tax. However, the assets will be taxed in your spouse's estate when they die, unless they also use strategies like portability or trusts to reduce their taxable estate.

What if my estate is below the exemption but I live in a state with an estate tax?

You may still owe state estate tax. Check your state's threshold — some states tax estates as small as $675,000. You may owe state tax even if you owe no federal tax. A tax professional in your state can tell you whether your estate crosses the state threshold.

Can I reduce my taxable estate by giving money to charity?

Yes. Charitable donations reduce your taxable estate dollar-for-dollar. You can also use a charitable remainder trust or donor-advised fund to get a tax deduction while retaining some control over how the money is used. A tax professional can help you structure this to maximize the benefit.

What happens if I die before filing Form 706 for portability?

Your executor has nine months from your death (or longer with an extension) to file Form 706 and elect portability. If they don't file, your spouse loses the ability to use your unused exemption, which can cost hundreds of thousands of dollars in tax. Make sure your executor knows this important date.

Does my 401(k) balance count toward my taxable estate?

Yes. The full balance of your 401(k), IRA, or other retirement account is included in your taxable estate at death. This is one reason people with large retirement accounts sometimes use life insurance or charitable strategies to offset the tax burden on heirs.