Key Takeaways
- The 2025 federal estate tax exemption is $13.99 million per person ($27.98 million for married couples).
- The annual gift tax exclusion is $19,000 per recipient for 2025.
- Beneficiary designations on retirement accounts and insurance override will provisions.
- Step-up in basis eliminates unrealized capital gains at death.
- Revocable trusts avoid probate but don't provide estate tax benefits.
- Irrevocable trusts remove assets from the taxable estate.
- Unlimited marital deduction allows tax-free transfers between spouses.
- The SECURE Act changed inherited IRA distribution rules with the 10-year rule.
Estate Planning Basics
Estate planning ensures assets are distributed according to the owner's wishes while minimizing taxes and avoiding unnecessary legal complications.
Key Estate Planning Documents
| Document | Purpose | When Effective |
|---|---|---|
| Will | Directs asset distribution | At death (through probate) |
| Revocable Living Trust | Holds assets, avoids probate | Immediately and at death |
| Irrevocable Trust | Removes assets from estate | Immediately |
| Power of Attorney | Designates financial decision-maker | During incapacity |
| Healthcare Directive | Medical treatment preferences | During incapacity |
| HIPAA Authorization | Allows access to medical records | During incapacity |
Wills
A will is a legal document that directs how assets should be distributed after death.
Types of Wills
| Type | Description |
|---|---|
| Simple Will | Basic distribution of assets |
| Testamentary Trust Will | Creates trusts upon death |
| Pour-Over Will | Transfers assets into existing trust |
| Holographic Will | Handwritten, unwitnessed (limited validity) |
Limitations of Wills
- Subject to probate (public, time-consuming, costly)
- Only covers probate assets (not retirement accounts, insurance, TOD accounts)
- Can be contested by heirs
- Provides no incapacity protection
Trusts
A trust is a legal arrangement where a trustee holds assets for the benefit of beneficiaries.
Revocable Living Trust
| Feature | Revocable Trust |
|---|---|
| Control | Grantor maintains full control |
| Changes | Can be modified or revoked |
| Probate | Avoids probate |
| Estate taxes | No reduction - included in estate |
| Asset protection | None during grantor's life |
Irrevocable Trust
| Feature | Irrevocable Trust |
|---|---|
| Control | Grantor gives up control |
| Changes | Cannot be modified (generally) |
| Probate | Avoids probate |
| Estate taxes | Assets removed from estate |
| Asset protection | Yes - protected from creditors |
Common Trust Types
| Trust Type | Purpose |
|---|---|
| Credit Shelter Trust (CST) | Maximize use of both spouses' exemptions |
| Charitable Remainder Trust (CRT) | Income to donor, remainder to charity |
| Charitable Lead Trust (CLT) | Income to charity, remainder to heirs |
| Qualified Personal Residence Trust (QPRT) | Transfer residence at reduced gift tax |
| Irrevocable Life Insurance Trust (ILIT) | Keep insurance proceeds out of estate |
| Grantor Retained Annuity Trust (GRAT) | Transfer appreciation at reduced gift tax |
Beneficiary Designations
These assets pass OUTSIDE the will directly to named beneficiaries:
- Retirement accounts (IRAs, 401(k)s, 403(b)s)
- Life insurance policies
- Annuity contracts
- Transfer-on-death (TOD) brokerage accounts
- Payable-on-death (POD) bank accounts
Critical: Beneficiary designations override will provisions. A divorced spouse still named as beneficiary will receive the assets, even if the will says otherwise.
2025 Gift and Estate Tax Rules
Annual Gift Tax Exclusion (2025)
| Gift Type | Amount |
|---|---|
| Per recipient | $19,000 |
| Married couple (gift splitting) | $38,000 per recipient |
| To non-citizen spouse | $190,000 |
| Direct tuition payments | Unlimited |
| Direct medical payments | Unlimited |
Lifetime Estate and Gift Tax Exemption (2025)
| Taxpayer | Exemption |
|---|---|
| Individual | $13.99 million |
| Married couple | $27.98 million (combined) |
| Tax rate above exemption | 40% |
Important Changes (OBBBA - July 2025)
Starting January 1, 2026:
- Lifetime exemption increases to $15 million per individual
- $30 million for married couples
- Indexed for inflation starting 2027
- Permanent (eliminates scheduled sunset)
Step-Up in Basis
At death, inherited assets receive a stepped-up basis to fair market value, eliminating unrealized capital gains.
Example:
- Original cost basis: $100,000
- Value at death: $500,000
- Heir's new basis: $500,000
- If heir sells for $500,000: NO capital gains tax
Community Property States
In community property states, both halves of jointly-owned property receive a step-up, not just the deceased spouse's half.
Community property states: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, Wisconsin
Unlimited Marital Deduction
Unlimited assets can transfer between spouses tax-free during life or at death (if surviving spouse is a U.S. citizen).
For non-citizen spouses, use a Qualified Domestic Trust (QDOT) to defer estate tax.
Exam Tip: Beneficiary designations OVERRIDE wills. The 2025 annual exclusion is $19,000 (increased from $18,000 in 2024). Step-up in basis eliminates unrealized gains at death.
An investor dies owning stock with a cost basis of $50,000 and a fair market value of $200,000. The heir sells the stock for $210,000. The taxable capital gain is:
Which of the following is NOT a probate asset?
In 2025, a married couple wants to give their daughter as much as possible without using any lifetime exemption. They may give up to:
Which type of trust removes assets from the grantor's taxable estate?
10.3 Special Accounts (Education and Health)
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