How to Minimize Inheritance Tax: Key Strategies

The federal estate tax is a tax on the transfer of a deceased person’s assets to their heirs. It taxes accumulated wealth at the time of death, impacting estates that exceed a certain value. Understanding this tax and implementing strategic planning can significantly reduce the tax liability, ensuring more of an estate’s value passes to intended beneficiaries.

Determining Your Taxable Estate

Understanding what comprises a taxable estate is necessary before implementing strategies to reduce estate tax. The gross estate includes the fair market value of all assets owned at death, encompassing real estate, financial accounts, personal property, and certain life insurance proceeds.

From this gross estate, certain deductions are allowed to arrive at the taxable estate. These deductions can include debts of the deceased, funeral expenses, and administrative costs incurred during estate settlement. The federal estate tax is then calculated on the value of the taxable estate that exceeds the federal estate tax exemption amount. For individuals dying in 2025, the basic exclusion amount is $13,990,000. Only the portion of the estate exceeding this threshold is potentially subject to federal estate tax.

Gifting Assets

Making gifts during one’s lifetime is a strategy to reduce the size of a taxable estate. The annual gift tax exclusion allows an individual to give a certain amount to any number of recipients each year without incurring gift tax or using up their lifetime exemption. For 2025, this annual exclusion is $19,000 per recipient. A married couple can effectively double this amount, allowing them to give $38,000 per recipient annually without tax implications.

Gifts exceeding the annual exclusion amount begin to reduce an individual’s lifetime gift tax exemption, which is unified with the estate tax exemption. This lifetime exemption stands at $13,990,000 per individual for 2025. Even if a gift exceeds the annual exclusion, it generally does not trigger an immediate gift tax payment; instead, it draws down this lifetime amount.

Beyond the annual exclusion and lifetime exemption, certain payments for medical expenses and tuition are entirely exempt from gift tax, regardless of the amount. These payments must be made directly to the educational institution or healthcare provider, not to the individual benefiting from the payment. This exemption provides an additional avenue for wealth transfer, allowing individuals to support loved ones’ education and health needs without impacting their annual or lifetime gift tax exclusions.

Utilizing Trusts

Certain types of trusts offer a method to remove assets from an individual’s taxable estate, reducing potential estate tax liability. Irrevocable trusts are effective for this purpose because once assets are transferred, the grantor generally relinquishes control and ownership. This removal of assets from the grantor’s direct control means they are typically excluded from the grantor’s estate for estate tax calculations.

One common example is an Irrevocable Life Insurance Trust (ILIT). An ILIT is designed to own life insurance policies, ensuring the death benefit proceeds are not included in the insured’s taxable estate upon their death. The trust, rather than the individual, owns the policy, and contributions to the trust to pay premiums can sometimes be structured to qualify for the annual gift tax exclusion. If an existing policy is transferred to an ILIT, the insured must survive for at least three years from the transfer date for the proceeds to be excluded from their estate.

The ILIT can provide liquidity to an estate to cover taxes and other expenses without increasing the estate’s taxable value. This can be useful for estates holding illiquid assets, such as a family business or real estate, where selling assets to pay taxes might otherwise be necessary.

Charitable Giving

Integrating charitable contributions into an estate plan can significantly reduce the taxable estate. Assets bequeathed to qualified charities are generally deductible from the gross estate, directly lowering the amount subject to estate tax.

The most straightforward method for charitable giving in estate planning is through direct bequests in a will. Such bequests ensure that a specified portion of the estate or particular assets pass directly to a qualified charitable organization. This direct transfer helps to reduce the overall size of the taxable estate.

Charitable trusts offer flexibility for those seeking more advanced strategies. A Charitable Remainder Trust (CRT) or a Charitable Lead Trust (CLT) allows individuals to benefit a charity while potentially retaining some income or providing for non-charitable heirs. These trusts can provide an estate tax deduction for the present value of the charity’s interest, reducing the taxable estate while fulfilling philanthropic goals.

Spousal Estate Planning

Married couples benefit from unique provisions within federal estate tax law that aid in minimizing tax liabilities. The unlimited marital deduction allows for the tax-free transfer of any amount of assets between spouses. This deduction applies whether the transfer occurs during life or at death, effectively postponing estate tax until the surviving spouse’s death.

This provision treats married couples as a single economic unit for estate and gift tax purposes, provided the recipient spouse is a U.S. citizen. While the marital deduction defers the estate tax, assets transferred to the surviving spouse will be included in that spouse’s taxable estate upon their subsequent death.

Another tool for married couples is the “portability” of the deceased spousal unused exclusion (DSUE) amount. This allows a surviving spouse to use any unused portion of their deceased spouse’s federal estate tax exemption in addition to their own. To elect portability, the executor of the deceased spouse’s estate must file a federal estate tax return (Form 706) in a timely manner, even if the estate is not otherwise required to file. This election allows a married couple to combine their individual exemptions, potentially shielding up to $27,980,000 from federal estate tax in 2025.