Part IV · Tax Regimes · No. 05

The estate tax

A 40% federal tax on the transfer of the taxable estate at death, integrated with the gift tax through a unified credit. The estate tax catches what a lifetime of gifting did not, and the §1014 basis step-up it produces is the most powerful planning rule in the Code.

The rule

The federal estate tax is imposed under chapter 11 of the Internal Revenue Code on the transfer of the taxable estate of every decedent who is a citizen or resident of the United States. §2001 imposes the tax; §§2031–2046 define the gross estate; §§2051–2058 define deductions. The tax is paid by the estate, not by beneficiaries.

The estate tax is integrated with the gift tax. Lifetime taxable gifts are added back to the taxable estate, the tentative tax is computed on the cumulative total, and prior gift tax paid is credited. A single unified credit (the basic exclusion amount at §2010) shelters the combined gift and estate tax.

The statutory basis

• §2001 — imposition of estate tax; rate schedule.
• §§2031–2046 — gross estate (property included).
• §§2051–2058 — taxable estate (deductions).
• §2010 — basic exclusion amount; portability of unused exclusion.
• §§2032, 2032A — alternate valuation date; special-use valuation for farm and closely held business real property.
• §2056 — marital deduction.
• §2055 — charitable deduction.
• §6166 — installment payment of estate tax attributable to closely held business interests.
• §1014 — basis adjustment to fair market value at death.

Scope

The gross estate is broad. It includes:

• Probate property — all assets the decedent owned outright at death, including bank accounts, securities, real estate, art, jewelry, vehicles, and tangible personal property.
• Life-insurance proceeds. Proceeds receivable by the estate, or proceeds on a policy in which the decedent held any incident of ownership at death, under §2042.
• Joint property. The full value of jointly owned property is included to the extent the decedent contributed (with a special rule for spouses, where each is treated as contributing half).
• Transfers with retained life estate or control. Property transferred during life with retained possession, enjoyment, or right to income is included under §2036 — a recurring trap in family-residence and art transfers.
• Transfers taking effect at death. §2037.
• Revocable transfers. §2038.
• Annuities. §2039.
• Powers of appointment. §2041 — general powers held at death cause inclusion of the property subject to the power.
• Qualified terminable interest property (QTIP). §§2044, 2056(b)(7) — property in which the decedent had only a qualifying income interest, where the predeceasing spouse's executor made the QTIP election, is included in the surviving spouse's estate.

For high-value luxury holdings the recurring inclusion points are the art collection (no longer in a freeport; owned outright or through a single-member LLC), trophy real estate held personally or through disregarded entities, art held in family partnerships where a §2036 retained-enjoyment argument may apply, and the residence itself.

Rate and computation

The rate schedule at §2001(c) is progressive in name but flat for high-value estates: the top rate of 40% applies to taxable amounts above approximately $1 million, and almost any taxable estate that reaches positive tax falls in the top bracket. The computation is:

1. Determine the gross estate at fair market value as of the date of death (or the alternate valuation date six months later, if elected).
2. Subtract deductions — marital, charitable, debts and expenses, state death tax — to determine the taxable estate.
3. Add lifetime adjusted taxable gifts.
4. Compute tentative tax on the sum.
5. Subtract gift tax paid (or payable) on prior gifts.
6. Subtract the unified credit attributable to the basic exclusion amount.
7. Net result is the estate tax payable.

Elections and exceptions

• Marital deduction (§2056). Property passing to a surviving U.S.-citizen spouse outright or in a qualifying form is deductible without limit. Transfers to a non-citizen spouse require a qualified domestic trust under §2056A.
• Charitable deduction (§2055). Bequests to qualifying charities are deductible without limit. For split-interest dispositions, see charitable-remainder trusts.
• Portability (§2010(c)). A deceased spouse's unused exclusion amount may be transferred to the surviving spouse if a complete Form 706 is timely filed with the portability election. The election preserves exclusion that would otherwise be lost.
• Alternate valuation date (§2032). The executor may elect to value the estate as of the date six months after death, but only if doing so reduces both the gross estate and the resulting tax.
• Special-use valuation (§2032A). Permits valuation of qualifying farm or closely held business real property at its actual-use value rather than its highest-and-best-use value, subject to a cap and recapture provisions.
• §6166 deferral. Estate tax attributable to a qualifying interest in a closely held business may be paid in installments over up to fourteen years at a reduced rate of interest. Significant for estates dominated by an operating business — including, sometimes, a family-office structure that qualifies. Estate of Robbie v. Commissioner, T.C. Memo. 1992-329, illustrated the application to a sports franchise.
• §303 redemption. A redemption of closely held stock to pay estate tax may be treated as a sale rather than a dividend distribution, with capital-gain rather than ordinary-income consequences.

Valuation of luxury assets at death

The valuation principle is the willing-buyer / willing-seller standard at Treas. Reg. §20.2031-1(b). For luxury assets the recurring battlegrounds are:

• Art. Appraisals are reviewed by the Art Advisory Panel for works valued above defined thresholds. Blockage discounts — where a decedent owned a large body of work by one artist whose simultaneous sale would depress price — were recognized in Estate of Smith v. Commissioner, 57 T.C. 650 (1972), and have produced ongoing case law including the recent Estate of Sonnabend matter on a partial-interest in a famous Rauschenberg work.
• Fractional interests in art. Discounts for lack of control and lack of marketability are routinely claimed; Estate of Elkins, 767 F.3d 443 (5th Cir. 2014), allowed substantial discounts on fractional interests.
• Closely held entities. Family-limited partnerships and LLCs holding marketable securities and real estate routinely produce discount claims of 25%–40% combined for lack of control and lack of marketability. The Tax Court has policed substance under §2036(a)(1) where the decedent retained the economic enjoyment of contributed assets; see Estate of Strangi v. Commissioner, 417 F.3d 468 (5th Cir. 2005), and the long line of FLP cases.
• Jewelry, antiques, household goods. Appraised by category; an estate inventory of luxury contents is the standard practice.
• Aircraft, yachts, vehicles. Appraised by qualified marine and aviation appraisers; market data for comparables is generally available.

The §1014 step-up

Property included in the gross estate takes a new basis equal to fair market value at the date of death (or alternate valuation date) under §1014. The income-tax effect is permanent forgiveness of all unrealized appreciation in the decedent's lifetime. For a collector who bought a painting for $200,000 and dies holding it at $20 million, the heirs take basis at $20 million, and the painting can be sold the next day with no income tax. The full $20 million is included in the gross estate, but if the unified credit shelters it, the appreciation passes free of all federal tax.

The interaction of §1014 with the gift tax — gifts carry over basis under §1015 — makes the choice between gifting and holding the central planning question. Gift away appreciated property and the donee inherits the basis. Hold to death and the basis steps up.

Interaction with other regimes

• Gift tax. Lifetime gifts integrate with estate tax through cumulative computation; the same unified credit covers both.
• GST tax. Inclusion in a generation-skipping arrangement triggers separate GST tax.
• State estate and inheritance tax. Twelve states and the District of Columbia impose state estate taxes with exemptions far below the federal level (Massachusetts and Oregon at $1 million and $2 million respectively as of recent years). Six states impose inheritance tax on the recipient. The state death-tax deduction at §2058 partially mitigates double tax.
• Income tax. §1014 step-up is the principal income-tax consequence. Income in respect of a decedent (IRD) — retirement accounts, deferred compensation, accrued interest — is excepted from step-up and remains ordinary income to the recipient under §691.
• Foreign estate tax. Several countries impose inheritance taxes on the decedent's worldwide estate or on the recipient. The estate-tax treaty network mitigates double tax in the principal cases.

Common planning approaches

• Use the lifetime exclusion before sunset. The doubled exclusion enacted in 2017 sunsets at end of 2025 absent legislation. Use during high-exclusion years preserves the larger shelter; anti-clawback regulations confirm no recapture on later death.
• Marital QTIP planning. The QTIP election permits the predeceasing spouse to use full exclusion while still leaving property for the surviving spouse's life.
• Dynasty trust. A dynasty trust in a no-rule-against-perpetuities state (South Dakota, Delaware, others) compounds assets free of estate tax for successive generations.
• Grantor-retained annuity trust. A GRAT moves appreciation in excess of the §7520 rate to remainder beneficiaries at low gift cost.
• Charitable lead and remainder trusts. Split-interest charitable structures reduce estate tax while preserving family economic benefit.
• Family-limited partnership. Holding luxury assets in an FLP and gifting LP interests at valuation discount removes value at reduced gift cost. The §2036 trap requires careful adherence to entity formalities.
• Life insurance held in an ILIT. An irrevocable life insurance trust holds policies outside the decedent's gross estate, providing liquidity for tax payment.

Recent developments

The 2025-end sunset of the doubled exclusion is the dominant pending variable. Without legislation the exclusion will roughly halve. Practitioners advised significant gifting during 2024-2025 to lock in the higher exclusion. The IRS has confirmed in regulations under §2010(c)(3) that pre-sunset gifts will not be clawed back.

The Corporate Transparency Act adds new beneficial-ownership reporting on family entities used in estate planning — see BOI reporting.

The IRS in 2022 finalized regulations under §2010(c) confirming portability mechanics and clarifying the period within which a Form 706 must be filed solely for portability (extended in Rev. Proc. 2022-32).

Reviewed May 2026