How Does The Death Tax Work?

Summary/TL;DR

Currently, the Estate Tax is only levied on those who pass away with a taxable estate worth $14M. Married couples can also utilize a provision in the tax code known as “portability” to effectively double the amount of this exclusion. Due to the volatile nature of the estate tax exclusion in the past, however, planning for the estate tax is still prudent at net worth thresholds well below the exclusion. Common strategies for reducing the size of one’s estate include transferring property to an irrecoverable trust (either during one’s lifetime or upon one’s death), utilizing a Donor Advised Fund, or using the annual Gift Tax exclusion to gift assets outright to family members.

Introduction

Perhaps no other tax is more feared, or more misunderstood, than the Estate Tax (commonly referred to as the “Death Tax"). The goal of today’s post is to explain how the Estate Tax works, who will be subject to it, and how you can mitigate it.

While today’s post will only discuss the Federal Estate Tax, it’s important to know that a few states, such as New York, have their own Estate Tax. These state programs often operate in an analogous fashion to the Federal Estate Tax and won’t be covered in today’s post.

The Basics

The Estate Tax is only levied on amounts of your estate over the “lifetime exclusion”, and is generally 40% of this total. In 2025, that exclusion is about $14M per individual, meaning that very few Americans will have taxable estates, leaving their assets to pass Estate Tax-free to their heirs. For example, if a Single taxpayer had a taxable estate worth $20M at their death, $14M would pass to their heirs free of estate tax, and $6M would be taxed at 40%, for a total tax of $2.4M.

It's also important to note that any life insurance death benefits will be included in your gross estate. If you aren’t careful, a large amount of this death benefit, which would usually pass to your beneficiaries tax-free, would be subject to the estate tax.

Portability

Portability is a provision in the tax code that allows a surviving spouse to use their deceased spouses’ unused exemption amount on their estate’s return when they eventually pass. Portability is not automatic. It must be elected on the deceased spouses’ Estate Tax Return (Form 706), and there is a five-year deadline for making this exemption.

Past And Future

It’s easy to look at the high estate tax exemption and dismiss the need for advanced estate planning. This could be a mistake, however, as the exemption amount has been all over the map historically and will likely continue to oscillate considerably with future legislative changes. In 2000, for example, the exemption was only $675,000, and in 2010 it was $5,000,000.

In fact, the current exemption amount, which was put in place through the Tax Cuts and Jobs Act of 2017, is scheduled to expire in 2026, bringing the exemption back down to about $7M per individual.

Given the high degree of unpredictability surrounding what the exemption will be at the time of one’s passing, most attorneys that I’ve talked with agree that advanced estate planning becomes necessary once one’s net worth enters the $4-6M range.

Planning For The Death Tax

All strategies for mitigating the estate tax involve reducing the size of your taxable estate. This can be accomplished by transferring assets to trust or by gifting assets outright to charity or family members.

Irrevocable Trusts

Irrevocable trusts are common estate planning vehicles used to reduce the size of one’s estate. Legal ownership of assets owned by an irrevocable trust are transferred to the trustee, and beneficial ownership is transferred to the trust’s beneficiaries. Because the grantor (the one who creates and transfers property to the trust) is giving up ownership of the assets, the assets will be removed from their estate for liability and tax purposes. I’ve written about them in a little more detail here.

There are many kinds of irrevocable trusts that can be used for different objectives. They can be created during your lifetime (inter vivos) or upon your death (testamentary). What’s important is that you and your financial planner work alongside a competent attorney to discuss the ins-and-outs of any potential trust solution, as decisions to transfer assets to an irrevocable trust are, as their title would suggest, irrevocable.

Donor Advised Funds

Think of a Donor Advised Fund (DAF) as a brokerage account for a charity. You can contribute cash, stock, or even property to the DAF in exchange for a charitable deduction equal to the fair market value of the gift in the year you make it. I’ve written about DAFs here. Not only are your donations tax deductible, but it’s irrevocable as well, so the assets are forever removed from your estate.

The greatest thing about DAFs is their flexibility. While your initial donation is deductible in the year you make it, your actual donations can be made whenever you’d like. Finally, DAFs are simple and easy to set up, administer, and operate.

Gifts

The final common strategy for reducing your taxable estate that we’ll discuss is gifts. Gifts can take the form of cash, stock, or even tangible property.

It’s important to keep a couple of numbers in mind when it comes to gifts. The first is the annual gift exclusion, which is $19,000 in 2025. This is the amount that an individual may give to another individual in a calendar year without incurring any Gift Tax consequences. The giftee will also not have to claim the gift as income on their tax return either. For example, a married couple has three children, all of whom are married, and want to give the total amount they can to each couple without triggering the Gift Tax. In this case, that total would be $228,000 per year, which is $19,000 for each child and spouse (6 individuals) given from both husband and wife.

Any amounts gifted over the annual exclusion in a calendar year will count towards your lifetime Gift Tax exclusion, which is equal to the Estate Tax lifetime exclusion mentioned above. If you dip into this exclusion, you will not be taxed while you are alive. Instead, this amount will be deducted from your Estate Tax lifetime exclusion at your death and increase your Estate Tax.

Conclusion

Fortunately, most Americans won’t need to worry about their heirs paying any Estate Tax due to the high exclusion currently in place. Those that do need to do some planning have some great options at their disposal that, when implemented alongside some creative and competent advisors, can produce hundreds of thousands, and in many cases millions, in Estate Tax savings for posterity.