Estate Tax Explained: Federal Exemption, State Inheritance, and How to Plan

The federal estate tax applies to about 0.1% of Americans who die each year — roughly 1,800 to 2,100 taxable estates out of 3.4 million annual deaths. The popular framing of a "death tax" crushing family farms is mostly myth, but the underlying regime is real, and it lives in a single chapter of the Internal Revenue Code. The 2024 federal exemption is $13.61 million per individual and $27.22 million per married couple, but twelve states and the District of Columbia also levy their own estate tax at thresholds as low as $1 million. Six other states impose an inheritance tax paid by the beneficiary, not the estate. This guide walks through every moving part, with worked examples and citations to the statutes that govern each rule.

The federal estate tax in plain English

The federal estate tax is codified at IRC §§ 2001–2210. Section 2001 imposes the tax on the "taxable estate" of every decedent who is a U.S. citizen or resident. Section 2010 provides the unified credit — the mechanism behind what most people call "the exemption." Sections 2031–2044 define the gross estate, which is broader than the probate estate: it sweeps in life insurance proceeds (if the decedent owned the policy), certain jointly held property, retirement accounts, gifts made within three years of death, and most transfers where the decedent retained control.

Three principles cut through almost every estate tax question. First, the tax is imposed on the right to transfer property at death, not on the property itself — which is why the recipient generally takes the assets income-tax-free under IRC § 102. Second, the tax is calculated on the taxable estate, meaning the gross estate minus deductions for debts, funeral and administration expenses, charitable bequests, and the marital deduction under IRC § 2056. Third, the unified credit effectively exempts the first $13.61 million (2024) of transfers — either during life as gifts or at death — from any tax.

The IRS publishes the official reference in Publication 559, and the Form 706 instructions walk executors through the actual mechanics of computing and paying the tax.

The 2024 exemption and the 2026 sunset

For decedents dying in 2024, the basic exclusion amount under IRC § 2010(c)(3) is $13.61 million per individual. For a married couple where both spouses die in 2024 and portability is properly elected, the combined exclusion is $27.22 million. The 2025 figure rises to $13.99 million per individual. These amounts are indexed for inflation and were doubled by the Tax Cuts and Jobs Act of 2017 (TCJA, P.L. 115-97).

The TCJA's doubled exemption is scheduled to sunset on December 31, 2025. Unless Congress acts — and several bipartisan proposals have circulated to extend or make permanent the higher exemption — the exclusion reverts on January 1, 2026, to roughly $7 million per individual (the pre-TCJA amount, adjusted for inflation to 2026 dollars). The IRS confirmed in Revenue Ruling 2023-2 that there will be no "clawback" of gifts made before the sunset: gifts covered by the higher exclusion in 2018–2025 will remain covered even if the donor dies after 2025 when the exemption is lower.

The sunset creates a narrow window. Anyone whose lifetime gifting strategy depends on the higher exemption should consider completing large gifts before December 31, 2025. Once the exemption drops, the additional exclusion amount is gone — it cannot be reclaimed.

For most families this matters less than the headlines suggest. The number of estates exceeding even a $7 million exemption is small. But for business owners with concentrated illiquid wealth, the difference between a $13.61 million and a $7 million exemption is roughly $2.6 million in additional estate tax at the top marginal rate.

How the tax is actually calculated

The estate tax is not a flat 40% on everything you own. It is computed in stages, and the effective rate on a taxable estate right at the exemption threshold is exactly 0%. The mechanics under IRC § 2001(c) work like this:

1. Compute the gross estate under IRC §§ 2031–2044 (everything the decedent owned or controlled, including life insurance on their own life).
2. Subtract deductions under IRC §§ 2053–2058: funeral and administration expenses, debts, casualty losses, charitable deduction, and the unlimited marital deduction for assets passing to a U.S. citizen spouse.
3. The result is the taxable estate. Add back lifetime taxable gifts made after 1976 to get the temporary estate tax base.
4. Apply the graduated rate table in § 2001(c): 18% on the first $10,000 up to 40% on amounts over $1,000,000. In practice, almost every taxable estate is large enough that the marginal rate is 40%.
5. Subtract the unified credit ($5,443,800 for 2024, equivalent to a $13.61M exemption at 40% rates).
6. The result is the federal estate tax owed (before any state death tax credit, which was phased out for federal purposes by 2005).

Worked example: a single decedent with a $20 million taxable estate in 2024. The tentative tax on $20M under the rate table is roughly $7,944,800. Subtracting the unified credit of $5,443,800 leaves $2,501,000 in federal estate tax. The effective rate on the taxable estate is about 12.5%, not 40% — the marginal rate is 40% but only the amount above the exemption is taxed.

Portability: Form 706 saves couples millions

Portability, added by the Tax Relief Act of 2010 and made permanent by ATRA in 2013, allows a surviving spouse to use any unused portion of the deceased spouse's estate tax exemption. The mechanics live in IRC § 2010(c)(4). For a married couple, portability effectively doubles the combined exemption to $27.22 million (2024) — but only if the surviving spouse elects it.

The election is made by the executor of the first spouse's estate, by timely filing a Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return. "Timely" means within nine months of death, with an automatic six-month extension available on Form 4768. A statement of election must appear on the Form 706.

The trap: Form 706 is required only if the gross estate exceeds the filing threshold ($13.61 million in 2024). Most first-spouse-to-die estates are below the threshold, and executors routinely skip the filing. Without the Form 706, portability is lost. The IRS issued Rev. Proc. 2022-32 providing a streamlined five-year retroactive extension specifically to remedy this — but relying on it is risky, and the broader § 2010(c)(5) "automatic extension" is still subject to a "reasonable cause" requirement.

Practical takeaway: if the first spouse dies with a gross estate anywhere near the filing threshold, file Form 706 anyway. The cost is a few thousand dollars in CPA fees; the upside is preserving millions in exclusion.

Step-up in basis: §1014's underrated benefit

For most families, the single most valuable provision in the entire Internal Revenue Code is IRC § 1014, which provides a "step-up" (or "step-down") in income tax basis for assets passing through a decedent's estate. Capital gains basis is reset to fair market value as of the date of death — meaning a stock bought for $10,000 that is worth $500,000 when the owner dies passes to the heir with a $500,000 basis. The $490,000 of unrealized gain is never subject to capital gains tax.

For a married couple in a community property state (AZ, CA, ID, LA, NV, NM, TX, WA, WI), both halves of community property receive a full step-up at the first spouse's death under IRC § 1014(b)(6). In separate property states, only the decedent's half of jointly held property gets a step-up; the surviving spouse's half retains its original basis. This is a meaningful but routinely overlooked difference — a couple holding $1 million of appreciated stock in California versus Illinois can face a six-figure capital gains gap when the surviving spouse eventually sells.

The step-up interacts with the estate tax in a subtle way: appreciation that has been "stepped up" is included in the gross estate for estate tax purposes. So § 1014 is not a tax avoidance provision — it is an income tax provision that converts what would have been capital gains tax into potentially estate tax. For estates under the federal exemption, the result is pure benefit (no estate tax, no income tax). For estates over the exemption, the result is mixed (estate tax at 40% vs. capital gains tax at 23.8% for top-bracket taxpayers).

Annual exclusion and lifetime exemption

The estate tax is formally a unified gift and estate tax system under IRC § 2502. The same $13.61 million lifetime exclusion applies to gifts made during life and transfers at death. The "annual exclusion" — currently $18,000 per donor, per donee, per year (2024) — sits on top of the lifetime exclusion. The annual exclusion rises to $19,000 in 2025.

Annual exclusion gifts do not reduce the lifetime exemption and do not require a gift tax return. A married couple can jointly give $36,000 to each child, each child's spouse, and each grandchild every year. With three children and six grandchildren, that is $324,000 per year moving out of the estate tax-free, with no Form 709 filing and no estate tax consequence.

Lifetime gifts above the annual exclusion consume the lifetime exemption dollar-for-dollar and must be reported on Form 709 (filed with the donor's income tax return by April 15 of the following year, with an automatic five-month extension available on Form 8892). Gifts of appreciated property carry the donor's basis to the donee under IRC § 1015 — which is why gifting highly appreciated stock to a child is often inferior, for income tax purposes, to holding it until death and letting § 1014 step up the basis.

Direct payments of tuition (IRC § 2503(e)) and medical expenses (paid directly to the provider) are excluded from gift tax entirely, with no dollar cap and no Form 709 filing. Grandparents paying private school tuition directly to the school is one of the most underused estate-planning moves available.

State estate tax: twelve states plus D.C.

Twelve states and the District of Columbia impose a separate estate tax, decoupled from the federal system. The state exemptions are dramatically lower than the federal $13.61 million — Oregon's is $1 million, Massachusetts's is $2 million. Residents of these states can face a meaningful state estate tax even when they owe nothing to the IRS.

Two structural traps deserve attention. New York's "cliff": estates exceeding the exemption by more than 5% lose the exemption entirely and pay tax on the full estate, not just the excess. A $7.35 million estate (just above $6.94M + 5%) pays roughly $580,000 — the same tax as a $7.35 million estate with no exemption at all. Washington and Oregon lack portability at the state level, so couples must use credit shelter (bypass) trusts to capture both spouses' exemptions.

State inheritance tax: paid by the beneficiary

Six states impose an inheritance tax, which is structurally different from an estate tax: the tax is levied on the recipient of the property, not on the estate. The rate depends on the relationship of the beneficiary to the decedent — closer relatives usually pay less, or nothing.

Note that Maryland is the only state that imposes both an estate tax and an inheritance tax — the estate tax applies to the estate as a whole, the inheritance tax applies to each beneficiary. Iowa's inheritance tax is being phased out and is fully repealed for deaths occurring on or after January 1, 2025.

Because inheritance tax is paid by the beneficiary, it can apply even when the estate is far below any estate tax threshold. A Pennsylvania decedent leaving $200,000 to a friend owes 15% — $30,000 — even though no federal or state estate tax would be triggered. Beneficiaries should ask the executor whether the will or state law specifies whether the inheritance tax is paid out of the residuary estate or out of the specific bequest (a so-called "tax apportionment" question).

A worked example: $18 million estate in Oregon

Consider an Oregon resident, widowed, dying in 2024 with a gross estate of $18 million: a $4 million home, $8 million in a brokerage account, $4 million in a traditional IRA, and $2 million in life insurance (which is includible in the gross estate under IRC § 2042 because she retained ownership of the policy).

Step 1 — Deductions. Funeral and administration expenses of $250,000, plus $1 million in charitable bequests, reduce the gross estate to $16.75 million. There is no marital deduction (widowed). The taxable estate is $16.75 million.

Step 2 — Federal estate tax. The tentative tax on $16.75M under the § 2001(c) table is roughly $6,594,800. Subtracting the unified credit of $5,443,800 leaves $1,151,000 in federal estate tax. (The life insurance proceeds, although includible in the gross estate, pass income-tax-free to the beneficiary under IRC § 101(a)(1).)

Step 3 — Oregon estate tax. Oregon's $1 million exemption is much lower. The Oregon tax on a $16.75 million taxable estate, computed under ORS 118.090's progressive rate table, is roughly $2.36 million — more than the federal tax. Oregon offers no portability and no state-level marital deduction beyond what's available federally.

Step 4 — Combined. Federal $1.151M + Oregon $2.36M = $3.51 million in death taxes, or about 19.5% of the gross estate. The effective rate is far below the 40% top marginal rate because most of the estate is sheltered by the federal exemption — but the state tax is what dominates this case.

Could this have been reduced? Yes — substantially. A $5 million irrevocable life insurance trust (ILIT) would have removed the $2 million policy from the gross estate. Annual exclusion gifting over the last decade could have moved another $1–$2 million out. A part-sale/part-gift to a grantor retained annuity trust (GRAT) on the appreciated brokerage account could have shifted appreciation out of the estate with little gift tax cost. The point is not that everyone needs these tools — it is that state estate tax, not federal, is what drives planning for most upper-middle-class families in the high-tax states.

Planning strategies for estates near the threshold

For estates comfortably under the federal exemption but exposed to state estate tax, the planning menu is narrower and more practical:

• Annual exclusion gifting. $18,000 per donee per year (2024). Mechanical, low-risk, and removes future appreciation from the estate.
• Direct tuition and medical payments under IRC § 2503(e). No dollar limit, no Form 709. Especially powerful for grandparents.
• Charitable bequests under IRC § 2055. A charitable bequest reduces the taxable estate dollar-for-dollar. Donor-advised funds and charitable remainder trusts offer flexibility.
• Irrevocable Life Insurance Trust (ILIT). Removes life insurance proceeds from the gross estate under IRC § 2042. The classic structure: the trust owns the policy, the trustee pays premiums with gifted funds, and the Crummey withdrawal power keeps the gifts qualifying for the annual exclusion.
• Portability election. Always file Form 706 for the first spouse to die if there is any chance the surviving spouse's estate could approach the federal or state threshold.
• State-specific credit shelter trust. In states without portability (Oregon, Washington), a bypass trust funded at the first death captures the deceased spouse's state exemption.

For estates exceeding the federal exemption, more aggressive tools come into play: GRATs, qualified personal residence trusts (QPRTs), family limited partnerships with valuation discounts, and sales to intentionally defective grantor trusts (IDGTs). These are not DIY instruments — they require experienced estate tax counsel and careful IRS reporting.

Common mistakes that cost families real money

Several recurring errors show up in estate tax practice, and most are avoidable:

• Skipping Form 706 when the estate is below the federal filing threshold. This loses portability. With a five-year retroactive fix available under Rev. Proc. 2022-32, the cost is now recoverable, but it is still time and fees the family should not have to spend.
• Owning life insurance on your own life. If the insured owns the policy, the proceeds are includible in the gross estate under IRC § 2042. An ILIT removes them.
• Forgetting state estate tax entirely. Many families plan for the federal exemption and discover at the second spouse's death that Oregon or Massachusetts will take 10–16% of everything above $1–2 million.
• Gifting appreciated property instead of holding it. The donor's basis carries over under IRC § 1015, while a step-up at death under § 1014 erases the gain entirely. For income tax purposes, holding usually beats gifting.
• Retaining incidents of ownership over transferred property — continuing to live in a "gifted" house rent-free, retaining voting control of gifted stock, or keeping a reversionary interest. These pull the asset back into the gross estate under IRC §§ 2036, 2038, or 2035.
• Mis-timing gifts in the sunset window. The 2026 sunset makes pre-2026 gifts more valuable, but only if they are completed. A $7 million gift made in December 2025 uses exemption that will not exist in 2026; the same gift made in January 2026 may not be fully covered.

Takeaways

The federal estate tax is a narrow tax: in 2024, only estates over $13.61 million (or $27.22 million for couples using portability) owe anything. But state estate and inheritance taxes reach much smaller estates — as low as $1 million in Oregon — and are often the real planning driver for upper-middle-class families. The four highest-leverage actions most adults can take: (1) ensure portability is elected at the first spouse's death by filing Form 706, (2) own life insurance through an ILIT rather than personally, (3) understand the difference between state estate tax (paid by the estate) and state inheritance tax (paid by the beneficiary), and (4) take advantage of annual exclusion gifting and direct tuition/medical payments to systematically shrink the taxable estate. For anyone approaching the federal threshold, the 2026 sunset is a deadline that should not be ignored.