What are Transfer Taxes?

Federal transfer taxes are taxes imposed at a rate of 40% on transfers (typically, other than certain transfers to a spouse or qualified charity) of certain types of property, either during life (gift tax) or at death (estate tax), if the total amount transferred exceeds the federal gift and estate tax exemption amount.  The federal gift or estate tax also may apply to certain transfers of property made during life and property over which an individual had certain rights or powers at the time of death.  The federal gift and estate tax form a unified system where taxable gifts made during life reduce the amount that can pass tax-free at death.

Federal Gift Tax

The federal gift tax is imposed at a rate of 40% on transfers (typically, other than certain transfers to a spouse or qualified charity) of property during life.  The gift tax is imposed only once the fair market value of property transferred during life in total exceeds the available gift and estate tax exemption amount.

Each individual can give up to the “annual exclusion amount” (in 2025, $19,000) to an unlimited number of recipients per year without triggering any gift tax or utilizing any gift and estate tax exemption. Married couples can combine their individual annual gift tax exclusions, even if only one spouse actually makes the gift, thereby effectively doubling the amount that can be given to each recipient tax-free (in 2025, $38,000).

Additionally, an individual may pay unlimited amounts for medical care and education expenses (e.g., tuition) for an unlimited number of recipients without incurring any gift tax, provided that such payments are made directly to the medical care provider or educational institution.

Federal Estate Tax

The federal estate tax is imposed at a rate of 40% on transfers (typically, other than certain transfers to a surviving spouse or qualified charity) of certain types of property at death.  The estate tax is imposed only to the extent that the fair market value of that property at the date of death exceeds any available gift and estate tax exemption amount.

Property subject to the federal estate tax includes everything a decedent owned in their individual name or had certain interests in at death.  Such property typically includes bank accounts, real estate, investments, business interests, insurance proceeds from insurance on their life, retirement accounts, personal property like jewelry and cars, and one-half of the value of all property held jointly.  The estate tax also may apply to certain transfers of property made during life and property over which an individual had certain rights or powers at the time of death.  However, property left to a spouse or qualified charity generally is not subject to the federal estate tax.

Unlimited Marital Deduction

The transfer tax marital deduction allows unlimited tax-free transfers between spouses, both during life (gift tax marital deduction) and at death (estate tax marital deduction), without using any lifetime gift and estate tax exemption. In other words, spouses can freely give each other money and property during life, and when one spouse dies, they can leave any amount to the surviving spouse outright or to certain types of trusts for the benefit of the surviving spouse without triggering transfer tax. However, if the recipient spouse is not a U.S. citizen, special rules apply. The unlimited marital deduction is part of the overall transfer tax system that generally treats married couples as a single economic unit for tax purposes and provides valuable time value of money benefits by postponing estate taxes until the second spouse's death.

Federal Gift and Estate Tax Exemption Amount

Each individual may transfer a certain amount of property during life or at death (in 2025, $13.99 million) without incurring any federal gift or estate tax.  To the extent this exemption amount is used against lifetime taxable gifts (i.e., other than gifts of the annual exclusion amount and qualifying payments for medical care and education expenses), it is not available for use at death.  For example, if an individual makes total taxable gifts of $1 million during life, they will be able to transfer $12.99 million at death (in 2025) without incurring federal estate tax, and any property transferred at death above $12.99 million will be subject to federal estate tax at a rate of 40%.

If an individual leaves any portion of their federal gift and estate tax exemption amount unused at death, the unused portion may be “ported” to the decedent’s surviving spouse for use by the surviving spouse during life or at death.  For example, if the first spouse to die uses only $3 million of their estate and gift tax exemption, the surviving spouse will have an additional $10.99 million (in 2025) that can be protected from federal gift or estate tax.

Unless Congress takes affirmative legislative action, the current federal gift and estate tax exemption amount is set to be cut roughly in half starting on January 1, 2026.  This means that starting, absent further legislative action, beginning in 2026, estates and lifetime gifts exceeding the lower exemption amount (estimated to be approximately $7 million) will be subject to a 40% federal gift or estate tax. For individuals and couples who have not yet used their current historically high exemption amount, this creates a potential "use it or lose it" situation before the end of 2025.

State Estate and Inheritance Taxes

In addition to any federal estate tax, a state estate or inheritance tax may also be due at death.  The exemption amounts, rates, and other details vary significantly by state. Typically, this tax can be used, at least in part, to offset the federal estate tax through a tax deduction.

The key difference between estate taxes and inheritance taxes is that estate taxes are paid by the estate based on the total value of the estate assets whereas inheritance taxes are paid by the individual beneficiaries based on what they receive (with rates often varying based on their relationship to the deceased).

• The following states impose a state estate tax: Connecticut; District of Columbia; Hawaii; Illinois; Maine; Massachusetts; Minnesota; New York; Oregon; Rhode Island; Vermont; and Washington.

• The following states impose a state inheritance tax: Iowa (being phased out); Kentucky; Maryland (has both estate and inheritance tax); Nebraska; New Jersey; and Pennsylvania.

A Note about the New York State Estate Tax:   The New York State estate tax operates alongside the federal estate tax, but with a much lower exemption amount (in 2025, $7.16 million). If a New York resident's estate exceeds the exemption amount by more than 5% (in 2025, exceeds $7.518 million), the estate is subject to a “cliff”--meaning that the estate loses the entire exemption amount and the full estate value is subject to the New York State estate tax up to a maximum rate of 16%.  While any New York estate tax paid is deductible on the federal estate tax return (reducing the federal tax), the combined tax burden can be substantial for larger estates that exceed both the state and federal exemptions.

What Trusts Qualify for the Marital Deduction?

A QTIP (Qualified Terminable Interest Property) Trust is a specialized estate planning tool that allows property to be held in trust for a surviving spouse and still qualify for the marital deduction (thereby deferring estate taxes until the surviving spouse's death). To qualify as a QTIP Trust, the surviving spouse must receive all income generated by the trust assets during their lifetime and may also receive principal distributions if needed. Additional benefits of creating a QTIP Trust for a surviving spouse include protecting assets for children after the second spouse’s death while still providing ongoing financial support for the surviving spouse.

What if my Spouse is Not a US Citizen?

Transfers to a surviving spouse or certain types of trusts for a surviving spouse are typically not subject to federal estate or gift tax because those transfers qualify for the unlimited marital deduction.  However, the marital deduction is not available in the same way for gifts during life or at death to a spouse who is not a US citizen.

For gift tax purposes, there is a special higher annual exclusion for gifts made to a non-citizen spouse (in 2025, $190,000). Gifts above the applicable amount in any given year count against the donor's gift and estate tax exemption or, to the extent there is no exemption remaining, are immediately subject to gift tax.  Additionally, gift splitting is not available if a spouse is a non-citizen at the time of the gift.

For estate tax purposes, unless the transfers are to a special type of trust called a Qualified Domestic Trust (QDOT), any transfers to a non-citizen spouse at death (including any property given to the surviving spouse outright) that exceed the deceased spouse's remaining exemption amount are immediately subject to federal estate tax.

If assets are transferred to a properly structured QDOT, the estate can defer estate taxes until the non-citizen surviving spouse's death or until trust distributions are made. QDOTs have specific requirements, including that at least one trustee must be a US citizen or domestic corporation, the executor must make a timely QDOT election on the estate tax return, and distributions of principal are generally subject to immediate estate tax unless made due to "hardship." The trust must also ensure that sufficient assets remain in the US to pay any deferred estate tax. This structure allows families with a non-citizen spouse to access similar (though not identical) estate tax benefits as those available to couples where both spouses are US citizens.

How Does Living in a Community Property State Impact Estate Taxes?

In community property states, each spouse automatically owns a 50% interest in property acquired during marriage (with some exceptions like inheritances). This impacts estate taxes in several important ways.

At the first spouse's death, both halves of community property get a stepped-up basis to fair market value - not just the deceased spouse's half. This is a major tax advantage over separate property states, where only the deceased spouse's share gets stepped up.

For estate tax purposes, only the deceased spouse's half of community property is included in their estate. However, if the property was acquired with the deceased spouse's separate funds but held as community property, special rules may apply.

The surviving spouse's half interest is not subject to estate tax at the first death since they already own it outright. It will be part of their estate when they later die, but with the stepped-up basis from the first death.

Community property rules can interact with estate planning techniques in complex ways - for example, they affect how property can be placed in certain types of trusts. However, the unlimited marital deduction still applies to transfers between spouses regardless of whether the property is community or separate property.

When and How are Federal Gift Taxes Paid?

While the donor is legally responsible for paying any gift tax, in practice most people never pay gift tax during life because they use their lifetime gift and estate tax exemption (in 2025, $13.99 million) to shelter lifetime gifts from tax. If a donor made any gifts during the year over the annual exclusion amount (in 2025, $19,000 or, $38,000 for married couples who elect to split gifts), the donor must file a gift tax return (Form 709) to report those gifts by April 15th of the year following the year in which the gifts were made (or October 15 if on extension), which reduces their remaining gift and estate tax exemption amount but doesn't trigger an immediate tax payment. Only when total lifetime taxable gifts exceed the exemption amount would actual gift tax become due and payable.  Gift taxes, when due, must be paid by April 15th of the year following the year in which the gifts were made regardless of whether the gift tax return is on extension.

Electing to Split Gifts

For married couples to elect to split gifts, both spouses must agree to split the gifts and file a gift tax return (Form 709).  The election applies to all gifts made by either spouse during that year - that is, you cannot choose to split some gifts but not others in the same year. Gift splitting isn't available for gifts to your spouse as these would fall under the unlimited marital deduction. You can't split gifts if you're divorced or if either spouse dies before filing the gift tax return. Once made, the consent to gift splitting is irrevocable.

What is the Generation-Skipping Transfer Tax (GST)?

The generation-skipping transfer (GST) tax is an additional layer of tax imposed at a rate of 40% on transfers to individuals two or more generations below the donor (or certain trusts for their benefit).  The GST tax was designed to ensure that wealth transfers do not skip a generation of tax collection–e.g., when wealth passes directly to a grandchild instead of a child, the transfer to the grandchild incurs a second layer of tax to take into account the “skipped” taxable transfer at the prior generation level.

Each individual has a separate GST exemption ($13.99 million in 2025) that can be allocated to shield transfers made to grandchildren or more remote descendants in the future from the GST tax. Proper planning and strategic use of the GST exemption during life can help preserve more wealth for future generations.

Like with the federal gift and estate tax exemption amount, unless Congress takes affirmative legislative action, the current GST exemption amount is set to be cut roughly in half starting on January 1, 2026 (estimated to be approximately $7 million).

Are There Ways to Mitigate the Impact of Gift, Estate and GST Taxes?

The annual gift tax exclusion is a powerful tool for transferring wealth, by allowing you to transfer assets tax free without using your lifetime exemption. In 2025, the annual gift tax exclusion is set at $19,000 per recipient or, for married couples who effectively elect to "split" gifts, $38,000 per recipient.

The lifetime gift and estate tax exemption (in 2025, $13.99 million) can be used during life rather than at death, which removes future appreciation from your estate. For married couples, portability allows a surviving spouse to use any unused portion of the deceased spouse's exemption.

Direct payments of educational and medical expenses for others are exempt from gift tax. However, these payments must be made directly to the educational institution or healthcare provider to qualify for the exemption.

Charitable giving strategies, including charitable lead trusts and charitable remainder trusts, can provide tax benefits while benefiting both charity and family. Direct charitable giving can also reduce your taxable estate.

Certain types of complex trusts and other estate planning vehicles and strategies can help reduce gift and estate taxes and future GST taxes by leveraging valuation discounts and removing future appreciation from your taxable estate. While these trusts and other estate planning strategies can offer powerful benefits, they require careful consideration for your specific situation, proper implementation and ongoing management. Some of these strategies may become relevant over time depending upon your specific assets and circumstances, but some people may not ever need to implement these strategies for an effective and successful estate plan (unlike core estate planning documents, which everyone should have). We will continue to update our FAQs and provide additional resources as these types of complex trusts and other techniques become available on the Steward platform.

What is Step-up in Basis and how does it work?

The step-up in basis is a significant tax benefit that applies to inherited property and can result in substantial tax savings for beneficiaries. When someone inherits property from an individual after that individual’s death, the property's tax basis is "stepped up" to its fair market value as of the date of death, effectively eliminating any built-in capital gains that occurred during the deceased owner's lifetime.

This means if a beneficiary sells inherited property soon after receiving it, they may owe little to no capital gains tax because their taxable gain would only be the difference between the sales price and the stepped-up basis value. For example, if someone inherited a property worth $1 million at the time of the owner's death, their new basis would be $1 million, regardless of what the deceased owner originally paid for the property.

The step-up in basis applies to many types of inherited property, including real estate, stocks, bonds, and other capital assets. However, it's important to note that certain types of assets, such as retirement accounts and assets that generate ordinary income, do not receive a step-up in basis. Additionally, for married couples in community property states, both halves of community property receive a step-up in basis when the first spouse dies.

Preserving a step-up in basis can be a crucial consideration in estate planning. Sometimes it may be more advantageous to hold appreciated assets until death rather than gifting them during life, as gifted assets retain the donor's original basis (known as "carryover basis"). However, this decision should be weighed against other estate planning objectives and potential estate tax implications.  Factors to consider include the size of the potential capital gains tax liability, the owner's life expectancy, the likelihood of future appreciation, and whether the estate will be subject to estate tax.