How the Estate and Gift Tax Exemption Works

The federal government imposes taxes on the transfer of wealth, both during a person’s life and at their death. The gift tax applies to assets given away while living, and the estate tax applies to assets transferred after death. Most individuals are unaffected by these taxes due to a tax credit known as the lifetime exemption, which is the total value of assets one can transfer tax-free.

For 2025, the lifetime exemption is $13.99 million per individual. A person can give away or leave an estate totaling this amount before any tax is owed. Any wealth transfers that exceed this cumulative lifetime limit are subject to a federal tax with a top rate of 40%.

The Unified Estate and Gift Tax Exemption

The federal tax system treats lifetime gifts and transfers at death as a single activity. The lifetime exemption is not two separate exemptions for gifts and the estate, but a single, unified limit that can be used for either type of transfer. This structure prevents individuals from avoiding the estate tax by giving away all their assets before death.

When an individual makes a taxable gift, the amount of that gift reduces their available lifetime exemption. A taxable gift is any amount given to a single person in a year that exceeds the separate, smaller annual limit. This reduction directly impacts the amount of exemption remaining to shelter assets from tax upon death.

For example, an individual with the full $13.99 million exemption in 2025 makes a taxable gift of $2 million. That amount is subtracted from their lifetime exemption, leaving $11.99 million available for future gifts or their estate. If this person later dies with a taxable estate valued at $12 million, the remaining exemption would be applied, leaving only $100,000 of the estate subject to the 40% tax.

The Annual Gift Exclusion

Separate from the lifetime exemption is the annual gift exclusion. This provision allows an individual to give a specific amount of money or property to any number of people each year without tax consequences. Gifts made under this annual exclusion do not count against the larger lifetime exemption. For 2025, the annual exclusion is $19,000 per recipient.

A person can give up to $19,000 in 2025 to their child, a friend, and any number of other individuals without needing to report the gifts or reduce their lifetime exemption. The exclusion is applied on a per-recipient basis, offering a way to transfer considerable wealth over time tax-free. For example, a person with three children could give each of them $19,000 in a single year, for a total of $57,000, with no impact on their unified credit.

Married couples can leverage this provision further through “gift splitting.” By agreeing to combine their individual annual exclusions, a couple can jointly give double the amount to a single recipient. In 2025, this allows a married couple to give up to $38,000 to any individual without using any of their lifetime exemptions.

Portability of the Exemption for Spouses

For married couples, a provision known as portability allows a surviving spouse to use any unused portion of their deceased spouse’s lifetime exemption. This unused amount is referred to as the Deceased Spousal Unused Exclusion (DSUE). This feature prevents the loss of a deceased spouse’s exemption and allows a couple to combine their individual exemptions.

If the first spouse to die does not use their entire exemption, the remainder can be transferred to the survivor. This happens frequently when most assets pass directly to the surviving spouse tax-free under the unlimited marital deduction. The DSUE amount is added to the surviving spouse’s own lifetime exemption, which can then be used for their own gifts or applied to their estate at death.

The transfer of the DSUE is not automatic. To secure this benefit, the executor of the deceased spouse’s estate must make a specific portability election. Failing to make a timely election means the DSUE is permanently lost, which could result in a higher estate tax liability for the surviving spouse’s estate.

The 2026 Sunset Provision

The current, high estate and gift tax exemption amount is not permanent. It was established by the Tax Cuts and Jobs Act of 2017, which included a “sunset provision” causing the increased levels to expire at the end of 2025. Barring new legislation, on January 1, 2026, the exemption amount is scheduled to revert to its pre-2018 level of $5 million, adjusted for inflation, which is estimated to be around $7 million per individual.

This pending change is a planning consideration for individuals with estates valued above the projected 2026 threshold. A person with a $12 million estate who dies in 2025 would owe no federal estate tax. If the same person died in 2026, their estate could face a tax bill of approximately $2 million.

To address concerns about making large gifts before the deadline, the Treasury Department and the IRS issued regulations known as the “anti-clawback” rule. This rule confirms that individuals who use the higher exemption for lifetime gifts will not be penalized if the exemption amount is lower in the year they die. The estate tax calculation will be based on the greater of the exemption amount used for lifetime gifts or the exemption in effect at the date of death.

Filing Requirements for Gifts and Estates

Compliance with estate and gift tax rules is handled through two primary IRS forms: Form 709 for gifts and Form 706 for estates.

A United States Gift Tax Return, Form 709, must be filed for any year an individual makes certain gifts. Filing is required for a gift to any single person that exceeds the annual exclusion amount ($19,000 for 2025). A return is also required for a gift of a “future interest,” regardless of its value, or if a married couple “splits” gifts to a third party. The deadline for filing Form 709 is April 15 of the year after the gift was made.

A United States Estate Tax Return, Form 706, is required under two main circumstances. The first is when the value of the decedent’s gross estate, plus their lifetime taxable gifts, exceeds the federal exemption for the year of death. The second is when the estate’s executor needs to elect portability of the Deceased Spousal Unused Exclusion (DSUE) to the surviving spouse, even if no tax is owed.

The deadline for filing Form 706 is nine months after the decedent’s date of death, though an automatic six-month extension can be requested. For estates not otherwise required to file, the IRS has provided a simplified method that extends the portability election window to five years after death. Filing these forms does not automatically mean tax is due, as they are often used simply to report a taxable gift or to make the portability election.