Estate Planning

The $15 million federal exemption, portability, and why most estates owe nothing

Under IRC Section 2010, every US citizen and resident is entitled to a unified credit against estate and gift tax that effectively exempts a certain amount of assets from federal estate tax. For 2026, the basic exclusion amount is $15 million per person. OBBBA made this elevated exemption permanent — unlike the temporary doubling under TCJA that was set to expire after 2025, the $15 million threshold (indexed for inflation) is now the baseline going forward. The estate tax rate on amounts above the exemption is 40% under IRC Section 2001(c).

Portability, codified in IRC Section 2010(c)(4), allows a surviving spouse to use the deceased spouse's unused exclusion amount (DSUE). If the first spouse to die used $3 million of their $15 million exemption (through lifetime gifts or a modest estate), the surviving spouse can claim the remaining $12 million in addition to their own $15 million exemption — for a combined exclusion of $27 million. Portability is not automatic; the executor must file Form 706 (United States Estate Tax Return) for the deceased spouse and elect portability, even if the estate owes no tax. This is one of the most commonly missed elections in estate planning. If Form 706 is not filed, the DSUE is forfeited permanently.

For the vast majority of self-employed individuals, the $15 million exemption means no federal estate tax will be owed. However, the exemption applies to the total value of your estate at death — including your home, business, retirement accounts, life insurance (if you own the policy), investment accounts, vehicles, and all other assets. Business owners with successful, growing enterprises should reassess their estate value periodically, because a business that is worth $2 million today could be worth $8 million in 15 years.

The federal estate tax exemption is $15 million per person for 2026 (permanent). Married couples can combine exemptions through portability for up to $30 million. The estate tax rate is 40% on amounts above the exemption. (IRC §2010; IRC §2010(c)(4); IRC §2001(c); OBBBA (permanent exemption))

Step-up in basis at death: the most valuable tax provision most people do not plan around

Under IRC Section 1014, assets included in a decedent's gross estate receive a new basis equal to the fair market value at the date of death (or the alternate valuation date, if elected under Section 2032). This "step-up in basis" eliminates all unrealized capital gains on appreciated assets, meaning the heirs can sell the assets immediately after death and owe zero capital gains tax on the appreciation that occurred during the decedent's lifetime.

For self-employed individuals, the step-up in basis is extraordinarily valuable for business assets, equipment, real property, and investment portfolios. Consider a plumber who purchased a commercial building for $200,000 twenty years ago that is now worth $800,000. If he sells it during his lifetime, he owes capital gains tax on $600,000 of gain (minus any depreciation recapture at ordinary rates). If instead the building passes through his estate at death, his heirs receive a basis of $800,000 and can sell for $800,000 with zero gain. At a 15% long-term capital gains rate plus 3.8% net investment income tax, the step-up saves $112,800 in federal taxes.

The step-up also applies to business interests. If you own a sole proprietorship, the individual assets of the business receive a step-up. If you own an interest in a partnership or LLC, the partnership's inside basis in its assets can be adjusted under Section 754 (if the partnership makes or has an existing Section 754 election) to reflect the step-up in the decedent's interest. For S corporation stock, the outside basis in the stock receives a step-up, but the inside basis of the S corporation's assets does not adjust absent a Section 338(h)(10) election.

One particularly powerful interaction: QSBS under IRC Section 1202 at death. If the decedent held qualified small business stock with unrealized gain that would have qualified for the Section 1202 exclusion, the step-up under Section 1014 eliminates the gain entirely — the heir takes a basis equal to fair market value and the Section 1202 exclusion becomes irrelevant because there is no gain to exclude. This means QSBS holders should generally not sell before death if estate planning permits holding.

Assets receive a new cost basis equal to fair market value at death, eliminating all unrealized capital gains for the heirs. (IRC §1014; IRC §754; IRC §1202; IRC §2032)

State estate taxes: 12 states with thresholds far below the federal exemption

While the federal estate tax exemption shelters $15 million, 12 states and the District of Columbia impose their own estate or inheritance taxes with much lower thresholds. This creates a significant planning challenge for business owners in these states, because an estate that owes nothing federally can owe hundreds of thousands in state estate tax.

The states with the lowest thresholds are Oregon ($1 million), Massachusetts ($2 million), and Washington ($2.193 million). Other states with estate taxes include Connecticut ($13.61 million — effectively matching the prior federal level), Hawaii ($5.49 million), Illinois ($4 million), Maine ($6.8 million), Maryland ($5 million — Maryland also has an inheritance tax), Minnesota ($3 million), New York ($7.16 million — with a "cliff" that eliminates the exemption entirely if the estate exceeds 105% of the threshold), Rhode Island ($1.774 million), Vermont ($5 million), and the District of Columbia ($4.71 million). State estate tax rates range from 0.8% to 20% depending on the state and the size of the estate.

Six states impose an inheritance tax instead of or in addition to an estate tax: Iowa (being phased out), Kentucky, Maryland (both estate and inheritance), Nebraska, New Jersey, and Pennsylvania. Inheritance taxes are paid by the individual heir based on their relationship to the decedent — typically spouses are exempt, lineal descendants pay lower rates, and unrelated heirs pay the highest rates.

For self-employed individuals in these states, the business value combined with a home and retirement accounts can easily exceed the state threshold. A plumber in Massachusetts with a $1.5 million business, a $600,000 home, and $400,000 in retirement accounts has a $2.5 million estate — above the $2 million Massachusetts threshold. Strategic options include gifting business interests during life, using irrevocable life insurance trusts to fund the state estate tax liability, and (for some) changing domicile to a state without an estate tax before death.

Twelve states and DC impose estate taxes with thresholds as low as $1 million. State estate tax applies independently of the federal exemption. (Varies by state; see OR ORS 118.005 ($1M); MA Ch. 65C §2A ($2M); WA RCW 83.100 ($2.193M))

Business succession, buy-sell agreements, and irrevocable life insurance trusts

For self-employed individuals, estate planning is inseparable from business succession planning. A business without a succession plan either dies with its owner or is sold under distress conditions at a fraction of its value. The three primary tools for business succession are: buy-sell agreements, key-person life insurance, and entity continuation provisions.

A buy-sell agreement is a legally binding contract that determines what happens to a business interest when an owner dies, becomes disabled, retires, or wants to sell. For sole proprietors, this typically takes the form of a redemption agreement with a key employee or an agreement with a competitor or complementary business. For partnerships and multi-member LLCs, cross-purchase agreements (where the surviving owners buy the deceased owner's interest) or entity redemption agreements (where the company itself buys the interest) are standard. The agreement should specify the valuation method (formula, appraised value, or fixed price), the payment terms, and the funding mechanism. Life insurance is the most common funding mechanism — each owner purchases a policy on the other owners' lives, and the death benefit provides immediate liquidity to complete the buyout.

An irrevocable life insurance trust (ILIT) removes life insurance proceeds from the insured's taxable estate. Without an ILIT, life insurance proceeds are included in the estate under IRC Section 2042 if the insured had any "incidents of ownership" in the policy (the right to change beneficiaries, borrow against the policy, surrender it, etc.). By transferring ownership of the policy to an irrevocable trust, the proceeds pass outside the estate entirely. For a business owner with a $2 million life insurance policy, this keeps $2 million out of the estate — potentially below a state estate tax threshold. The ILIT must be the owner and beneficiary of the policy, and the insured must not retain any incidents of ownership. Existing policies transferred to an ILIT are subject to a 3-year lookback under Section 2035 — if the insured dies within 3 years of the transfer, the proceeds are pulled back into the estate.

Annual exclusion gifting is another foundational tool. Under IRC Section 2503(b), you can gift up to $19,000 per recipient per year (2026) without using any of your lifetime exemption. A business owner with three children can transfer $57,000 per year ($114,000 if the spouse joins in gift-splitting under Section 2513) in business interests or other assets completely tax-free. Over 20 years, this can transfer over $2 million out of the estate without touching the $15 million lifetime exemption.

Buy-sell agreements funded by life insurance provide liquidity for business succession. ILITs remove life insurance proceeds from the taxable estate. Annual exclusion gifts of $19,000 per recipient reduce the estate over time. (IRC §2042; IRC §2035; IRC §2503(b); IRC §2513)