Reducing Estate Taxes

Estate taxes are imposed after your death, on property you leave at your death. Because everyone is entitled to a very large estate tax exemption, only a small number of estates end up owing it.

The Federal Estate Tax

The vast majority of Americans do not need to worry about federal estate tax, because under the current rules, only very very large estates owe this tax. Here's why:

The personal estate tax exemption. The personal exemption allows a set dollar amount of property to pass tax free, no matter who inherits it. For deaths in 2021, the personal exemption is $11.7 million. So if you die in 2021 and your estate is worth less than $11.7 million, it won't owe federal estate tax. This exemption amount rises annually with inflation. Also, if you have made taxable gifts during your life, the amount of the personal exemption will be reduced by the amount of those taxable gifts.

The marital deduction. All property left to a surviving spouse passes free of estate tax. (The marital deduction does not apply to noncitizen spouses.)

The charitable deduction. All property left to a tax-exempt charity is also free of estate tax.

An additional option for married couples. Through "portability" married couples can share their personal exemptions. This allows a surviving spouse to claim any unused portion of the deceased spouse's exemption. In effect, this gives married couples a shared $23.4 million exemption.

EXAMPLE: Juan dies in 2021 and leaves $12 million to his widow Janice. Because property left to a spouse is tax free, no estate tax is owed and none of Juan's personal exemption is used.

Later that year Janice dies, leaving $20 million (her own $8 million plus the $12 million she inherited from her husband) to her children. Her estate won't owe any estate tax either—here's why: The first $11.7 million is covered by her own personal exemption. The remaining $8.3 million is covered by Juan's completely unused personal exemption. Janice's estate would owe tax only if it had grown to over $23.4 million.

Unless you plan to leave many million dollars' worth of property, you don't need to give federal estate taxes a second thought. If you do expect to leave a very large estate, consult a tax professional or estate planning attorney to discuss tax planning.

For more information about federal estate taxes go to the "Estate and Inheritance Taxes" section of Nolo.com.

State Estate and Inheritance Taxes

Even if your estate isn't big enough to owe federal estate tax, the state may still take a bite.

Estate tax. A handful of states collect their own estate taxes. Like the federal government, states exempt a large amount of property from each estate. For deaths in 2021, state exemption amounts range between about $1 and $6 million, most increasing over time with inflation. All of the state exemptions are significantly lower than the federal exemption. So, depending on which state you live in and how much property you own, your estate could end up owing state estate taxes, even if it doesn't owe federal estate tax. Go to Nolo.com to find out whether your state has an estate tax and to learn the amount of the personal exemption if it does.

Inheritance tax. Several states impose a separate tax on a deceased person's property, called an inheritance tax. The tax rate depends on who inherits the property; usually, spouses and other close relatives pay nothing or at a low rate. Go to Nolo.com to learn more about state inheritance taxes in your state.

If you're worried that your estate might owe state estate or inheritance taxes, see an experienced estate planning lawyer or tax professional to find out whether you can make a plan to avoid or reduce these taxes.

Ways to Reduce Federal Estate Tax

If you have a very large estate, here are some tax-saving strategies you may want to talk about with a tax adviser or estate planning attorney. Each can be used alone or in combination with other methods.

Annual Tax-Exempt Gifts

If you don't need all your income and property to live on, making sizable gifts while you're alive can be a good way to reduce eventual federal estate taxes before that tax is repealed. Currently, only gifts larger than $15,000 made to one person or organization in one calendar year count toward the personal estate tax exemption. You can give smaller gifts tax-free.

EXAMPLE: Allen and Julia each give each of their two daughters $15,000 every year for four years. They have transferred $240,000 without becoming liable for gift tax.

Other Tax-Exempt Gifts

Other gifts are exempt regardless of amount, including:

  • gifts between spouses who are U.S. citizens (gifts to spouses who are not U.S. citizens are exempt only up to $159,000 per year)
  • gifts paid directly for medical bills or school tuition, and
  • gifts to tax-exempt charitable organizations.

AB Living Trusts

AB living trusts are designed to help couples with very large estates reduce or eliminate estate tax. However, for married couples, the current federal estate tax rules (see above) make this type of trust useful only if their combined estate is greater than $23.3 million. Needless to say most married couples do not need an AB trust under these new rules.

That said, you might still consider making an AB trust if:

  • You and your spouse or partner have a large estate and are worried that changes to estate tax laws might cause you to owe taxes. In this case, you might consider making an AB disclaimer AB disclaimer trusts provide flexibility under changing tax laws.
  • You and your partner aren't legally married. Unmarried couples won't qualify for the special rules for married couples described above and an AB trust could be useful if you and your partner have a combined estate worth more than $11.7 million.
  • You might owe state estate tax. If you live in a state that has an estate tax with an exemption that's lower than the federal exemption, you may owe state estate tax, even if you don't owe federal estate tax. (See above.) An AB disclaimer trust could help you and your spouse or partner avoid or reduce these state taxes.

Keep in mind that AB trusts limit the surviving spouse's ability to use trust property, can be expensive to create and in some situations can cause stress among family members. So, if you think that an AB trust might be useful for you, do some more research on your own or discuss your options with an experienced estate planning attorney. Learn more about AB trusts on Nolo.com.

Charitable Trusts

If you want to make a big contribution to a charitable cause you care about—and, at the same time, cut your income taxes now and guarantee some income for life—then a charitable trust may be for you. They're not just for the very rich; some charitable trusts have minimum contributions of a few thousand dollars, and others have no minimum at all.

QTIPs and QDOTs

These trusts, known by their catchy acronyms (easier to say than Qualified Terminable Interest Property trust, you have to admit), are mainly used by married couples concerned about estate tax. A QTIP lets couples postpone paying estate tax until the second spouse's death and also locks in, while both are still alive, who inherits the property at the second spouse's death. A QDOT is useful when a spouse who is not a U.S. citizen stands to inherit a large amount of property.

Life Insurance Trusts

  • Although the proceeds of a life insurance policy don't go through probate, they are included in your estate for estate tax purposes. You can reduce the tax bill by giving ownership of the policy to a life insurance trust (or to the beneficiary directly) at least three years before your death. But like other estate tax-saving strategies, this one will have to be reassessed in light of any changes in estate tax law.