The federal estate tax exemption determines how much of a person’s estate can be passed on to heirs without incurring federal estate taxes. With tax laws in flux and significant changes on the horizon, understanding how to use this exemption effectively can mean the difference between preserving wealth for future generations or incurring a substantial tax burden.
How does the federal estate tax exemption work? What changes can be expected in 2026? How can you maximize its benefits?
Understand the federal estate tax exemption
The federal estate tax exemption refers to the amount of an estate that can be transferred to heirs tax-free upon death before federal estate taxes apply. Any amount exceeding the exemption is taxed at 40 percent.
For 2025, the exemption is set at $13.99 million per individual, a slight increase from $13.61 million in 2024. Proper planning means a married couple can shield nearly $28 million from estate taxes. Estates valued under this threshold will not be subject to federal estate taxes.
The current high exemption was established under the Tax Cuts and Jobs Act of 2017, doubling the previous exemption. However, these provisions are set to expire at the end of 2025. If no legislative action is taken, the exemption will revert to its pre-2018 levels (approximately $5.49 million per individual, adjusted for inflation). Based on projected adjustments, experts estimate the 2026 exemption to be around $7 million, but the final amount will depend on IRS calculations.
For high-net-worth individuals, this reduction poses a significant planning challenge. If your estate is valued above the anticipated $7 million individual exemption or $14 million for married couples, you could face estate tax exposure that does not exist under current law.
Given this looming change, 2025 presents a unique window of opportunity to take advantage of the higher exemption levels before they are reduced.
How to leverage the federal estate tax exemption
Consider the following strategies to maximize your estate planning and minimize potential tax liabilities.
Lifetime gifting : One of the most effective ways to leverage the estate tax exemption is through lifetime gifting.
The federal tax code allows individuals to transfer wealth tax-free during their lifetime by utilizing the estate and gift tax exemption, set at $13.99 million per person in 2025. However, this exemption is not an annual limit but a cumulative cap that applies to lifetime gifts and assets passed through an estate at death.
In addition to this lifetime exemption, individuals can make annual exclusion gifts—up to $19,000 per recipient in 2025—without reducing their lifetime exemption. Any gifts exceeding the annual exclusion amount will count toward the lifetime exemption, reducing the available tax-free amount at death. You can maximize tax-efficient wealth transfers using the annual exclusion and lifetime exemption.
Reducing your taxable estate by gifting assets now lowers its overall taxable value. If you expect certain assets like stocks, real estate, or business interests to appreciate significantly, gifting them ensures that all future growth occurs outside your taxable estate.
Establish irrevocable trusts : An irrevocable trust is another powerful tool for leveraging the estate tax exemption. These trusts remove assets from your taxable estate while allowing you to control how and when your heirs receive their inheritance.
Some popular trust strategies include Spousal Lifetime Access Trusts, which allow one spouse to gift assets to an irrevocable trust while allowing the other spouse access to income and distributions. This keeps the assets outside the taxable estate while still providing financial security.
Irrevocable Life Insurance Trusts ensure that life insurance death benefits are not subject to estate tax by placing the policy within the trust.
Grantor-retained annuity trusts are powerful estate planning tools designed to transfer appreciating assets to beneficiaries while minimizing gift taxes. This strategy is particularly beneficial when assets are expected to grow significantly over time.
With a GRAT, the grantor transfers assets into an irrevocable trust while retaining the right to receive fixed annuity payments from the trust for a set term. These payments are calculated using an IRS-prescribed interest rate (the Section 7520 rate). If the assets in the GRAT appreciate at a rate higher than this assumed rate, the excess growth passes to the beneficiaries free of gift and estate taxes.
At the end of the GRAT term, any remaining assets in the trust are transferred to the beneficiaries, reducing the grantor’s taxable estate.
However, if the grantor does not survive the GRAT term, the assets are included in the estate, negating the tax benefits.
Proper structuring and careful selection of assets with high appreciation potential make GRATs an effective strategy for wealth transfer.
Here’s an example.
Jane, a successful business owner, transfers $1 million in stocks into a GRAT and retains the right to receive $100,000 annually for 10 years, based on a 2% IRS Section 7520 rate. If the stocks appreciate at 7% per year, the trust’s value at the end of the term will be around $1.4 million.
After receiving $1 million in annuity payments, the remaining $400,000 (the excess growth) is transferred to her children free of gift and estate taxes.
Using Family Limited Partnerships and valuation discounts
A Family Limited Partnership (FLP) allows you to transfer assets to family members while maintaining control over how the assets are managed. The FLP structure also provides opportunities for valuation discounts, which can further reduce estate tax liability.
Parents contribute assets to an FLP and retain general partnership interests to maintain control. Limited partnership interests are transferred to children or heirs at a discounted valuation, reducing taxable value. Since limited partners have no control, the IRS allows a valuation discount, often ranging from 10 to 40 percent, lowering the taxable estate.
The IRS closely scrutinizes these discounts, particularly when FLPs are structured primarily to reduce estate tax liability rather than serve a legitimate business purpose.
For a valuation discount to be upheld, the FLP should demonstrate clear economic and operational justifications, like joint management of family assets, asset protection, or centralized investment control.
Courts have frequently ruled against excessive valuation discounts when FLPs lack a legitimate business purpose, or the grantor retains significant control over the assets, making them indistinguishable from personal holdings.
Consulting with an experienced estate planning attorney and financial advisor can help ensure the FLP meets legal requirements while maximizing tax benefits.
Gifts and sales to trusts : An “intentionally defective grantor trust” (IDGT) is a type of trust where the grantor retains certain powers, making the trust’s income taxable to them while keeping the trust assets outside their estate for estate tax purposes.
Although the grantor is considered the trust’s owner for income tax purposes, the trust is treated as a separate entity for estate tax purposes. This structure allows the grantor to pay income taxes on the trust’s earnings, effectively reducing the value of their taxable estate.
Combining gifts with sales to an IDGT can effectively leverage the current exemption limit while maintaining flexibility. This strategy allows you to gift a portion of your assets to the trust tax-free under the exemption limit. You can sell other assets to the trust in exchange for a promissory note, which helps avoid gift taxes on this transaction.
By doing so, you effectively remove any future appreciation on the sold assets from your estate. As a result, the taxable value of your estate decreases while the grantor continues to pay taxes on the income generated by the trust, further lowering the overall taxable estate value.
Here’s an example of how this strategy could work.
Assume you have an estate valued at $5 million and want to gift some of your assets to your children while minimizing estate taxes. You set up an IDGT and gift the trust $1 million worth of assets (like stocks), taking advantage of the current gift tax exemption limit. This portion of the estate is now outside of your taxable estate.
Next, you sell a piece of real estate worth $2 million to the trust in exchange for a promissory note. Since this is a sale, not a gift, it does not incur gift taxes. The trust holds the property, and your estate will not reflect any appreciation. As the grantor, you continue to pay taxes on the income generated by the trust assets, which further reduces your taxable estate.
While selling assets to an IDGT can be an effective estate planning strategy, proper structuring is crucial to avoid IRS challenges. To ensure the transaction is considered a legitimate sale rather than a disguised gift, it should include:
A seed gift : Before the sale, the grantor typically funds the trust with a seed gift, often around 10% of the total asset value. This helps establish the trust’s financial independence and supports its ability to make payments on the promissory note.
An arm’s-length promissory note : The sale should be executed using a formal promissory note with commercially reasonable terms, including an interest rate at or above the IRS-prescribed Applicable Federal Rate (AFR). The trust makes periodic payments to the grantor based on this note.
By structuring the sale correctly—ensuring that the trust has sufficient assets, following standard lending practices, and maintaining proper documentation—the strategy is more likely to withstand IRS scrutiny while effectively transferring asset appreciation outside the taxable estate.
Common mistakes to avoid
When planning around the estate tax exemption, avoid common pitfalls that could reduce the effectiveness of your strategy.
Waiting too long to implement strategies may result in missed opportunities, especially if legislative changes occur. If you delay acting until late 2025, you risk missing the chance to take full advantage of the higher exemption before it decreases.
Failing to consider state estate taxes can lead to unexpected liabilities. Some states impose their own estate or inheritance taxes with lower exemption thresholds than the federal government. Proper planning should account for both federal and state tax implications.
Not updating estate plans regularly can lead to outdated strategies that no longer align with current laws or financial goals. Estate plans should be reviewed frequently to ensure they are effective and account for changing personal circumstances.
Final thoughts
With the federal estate tax exemption set to drop significantly in 2026, now is the time to act. Using strategies like lifetime gifting, annual exclusion gifts, irrevocable trusts, Family Limited Partnerships, and gifts and sales to trusts, you can minimize estate tax exposure and pass on more wealth to your heirs.
Estate planning is complex, and tax laws can change unexpectedly, so working with a qualified estate planning attorney or tax professional is essential. A financial advisor who is also a certified public accountant is an especially valuable resource.
Taking proactive steps can ensure your legacy is preserved and you make the most of the current exemption before it’s gone.
Disclaimer: There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk. Content in this material is for general information only and is not intended to provide specific advice or recommendations for any individual. All investing involves risk, including loss of principal. No strategy ensures success or protects against loss.