You can reduce or eliminate estate tax with the right kind of trust, but only an irrevocable trust does the work. A revocable living trust keeps assets in your name for tax purposes and saves nothing. Whether a trust also shields your heirs from a state inheritance tax is a separate question that depends entirely on which state’s rules apply, because inheritance tax is charged to the person receiving the assets rather than to the estate itself.
Estate Tax and Inheritance Tax Are Not the Same
The two terms get used interchangeably, but they hit different people. An estate tax comes out of the deceased person’s estate before anything reaches the heirs. The federal government charges one, and so do 12 states plus the District of Columbia. An inheritance tax is paid by the person receiving the assets. There is no federal inheritance tax, but five states levy one: Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania.
That distinction matters for what a trust can actually accomplish. An irrevocable trust removes assets from the taxable estate, which directly attacks estate tax. Whether the same trust shields a beneficiary from a state inheritance tax depends on that state’s rules, since some states tax what a beneficiary receives regardless of how it was held. Maryland is the only state with both taxes, so beneficiaries there can face two layers of state-level tax on the same assets.
Where the Federal Exemption Sits for 2026
The federal estate tax exemption is $15 million per individual for 2026, or effectively $30 million for a married couple using portability.1Internal Revenue Service. What’s New — Estate and Gift Tax Estates below that line owe no federal estate tax. Above it, the top rate is 40%. The $15 million figure is now permanent and will continue to adjust for inflation.
State estate taxes are the reason trust planning still matters for many people who are nowhere near the federal threshold. The 12 states and D.C. that impose their own estate taxes set exemptions ranging from $1 million to $13.99 million, with top rates between 12% and 35%. A trust strategy can save significant money at estate sizes that the federal system ignores entirely.
Why a Revocable Trust Does Nothing for Taxes
A revocable trust, sometimes called a living trust, lets you move assets into a trust while keeping full control. You can change the terms, pull assets back out, or dissolve it whenever you want. That control is exactly why the IRS treats everything inside it as yours. Income generated by the assets goes on your personal return, and when you die, the full value gets included in your taxable estate.2Internal Revenue Service. Trust Primer
Revocable trusts do avoid probate, which saves time and keeps the estate out of public court records. Useful, but not a tax strategy.
How an Irrevocable Trust Reduces Estate Tax
An irrevocable trust is the actual tool. Once you transfer assets in, you generally cannot take them back, change the beneficiaries, or alter the terms without the beneficiaries’ consent, and sometimes court approval.3The American College of Trust and Estate Counsel. Can I Change My Irrevocable Trust? You give up legal ownership. That is the mechanism.
Because the assets are no longer yours, they are not part of your taxable estate. Someone with a $20 million estate who transfers $5 million into an irrevocable trust brings the taxable estate down to $15 million, which at the 2026 exemption level could zero out the federal estate tax. The same logic applies at the state level, where lower thresholds make the strategy relevant at much smaller estate sizes.
Irrevocable trusts also provide asset protection. Once assets are properly transferred and enough time has passed, personal creditors generally cannot reach them. Courts will unwind a transfer made to dodge existing debts, but for legitimate long-term planning, the protection holds.
Irrevocable Life Insurance Trusts
Life insurance proceeds are included in your taxable estate if you own the policy when you die. A $3 million term policy adds $3 million to the estate. An irrevocable life insurance trust, or ILIT, solves this by owning the policy in your place. The trustee holds the policy, pays the premiums (often with gifts from you), and collects the death benefit. Because you never owned the policy, the proceeds stay out of your estate.
One trap with existing policies: if you transfer a policy you already own into an ILIT and die within three years, the proceeds get pulled back into your taxable estate.4Office of the Law Revision Counsel. 26 USC 2035 – Adjustments for Certain Gifts Made Within 3 Years of Decedent’s Death This is why many planners have the ILIT buy a new policy from scratch rather than transferring an old one.
Grantor Retained Annuity Trusts
A grantor retained annuity trust, or GRAT, is built to move future appreciation to your beneficiaries with little or no gift tax. You place assets in the trust and receive fixed annuity payments back over a set term. Whatever remains at the end of the term passes to the beneficiaries.
The IRS calculates the taxable gift by subtracting the present value of your annuity payments from the initial contribution. Structure the annuity so it roughly equals the contribution plus an IRS-prescribed interest rate, and the taxable gift can be close to zero. Any growth above that rate passes to the beneficiaries free of gift and estate tax. The strategy works best with assets you expect to appreciate quickly. The main risk is timing: if you die during the GRAT term, the assets snap back into your taxable estate.
The Gift Tax Side of the Transfer
Putting assets into an irrevocable trust counts as a gift to the beneficiaries. The annual gift tax exclusion is $19,000 per recipient for 2026, so you can give that amount to each beneficiary each year with no gift tax consequences.5Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026, Including Amendments From the One, Big, Beautiful Bill
Transfers above that amount require a gift tax return (Form 709), but usually no tax is owed. The excess reduces your lifetime gift and estate tax exemption, which is the same $15 million that will shelter your estate at death.1Internal Revenue Service. What’s New — Estate and Gift Tax Every dollar of the lifetime exemption you use during life is a dollar less available to shelter your estate later.
The Step-Up in Basis You Give Up
This is the hidden cost that catches people off guard. When someone dies, the assets they owned normally get a “step-up” in tax basis to fair market value at the date of death.6Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent Stock your parent bought for $50,000 that is worth $500,000 at their death comes to you with a $500,000 basis. Sell it the next day and you owe no capital gains tax.
Assets in a revocable trust still get this step-up because they were in the taxable estate. Assets in an irrevocable trust that were excluded from the gross estate do not. The IRS confirmed this in Revenue Ruling 2023-2: if the assets are not part of the taxable estate, the basis carries over unchanged.7Internal Revenue Service. Revenue Ruling 2023-2 – Basis of Property Acquired From a Decedent
Same example, different result. If that $50,000 stock is in an irrevocable trust when your parent dies, the basis stays at $50,000. When the trust eventually sells or distributes it, $450,000 of capital gain is on the table. At the 20% federal long-term rate, plus the 3.8% net investment income tax for high earners, that is potentially more than $100,000 in taxes the step-up would have wiped out.
So the honest comparison is this: does the estate tax you avoid by moving the asset out exceed the capital gains tax your beneficiaries will eventually pay because they inherited the old basis? For estates well above the exemption, estate tax at 40% usually wins. For estates near or below the exemption, giving up the step-up in exchange for no estate tax benefit is a loss.
Trust Income Gets Taxed at the Top Rate Almost Immediately
Irrevocable trusts that are not structured as grantor trusts pay income tax on undistributed earnings at their own compressed brackets. For 2026:8Internal Revenue Service. Revenue Procedure 2025-32
- 10% on taxable income up to $3,300
- 24% from $3,301 to $11,700
- 35% from $11,701 to $16,000
- 37% over $16,000
Individual filers do not hit 37% until income exceeds $640,600. A trust gets there at $16,000. Any trust holding rental property or dividend-paying stocks will feel that compression fast.
There are two standard workarounds. The trust can distribute income to beneficiaries, who then pay at their own (usually lower) individual rates; the trust deducts the distribution and the beneficiary reports it. Or the trust can be intentionally structured as a “grantor trust” for income tax purposes, so the grantor pays the income tax personally while the assets remain outside the estate. The grantor’s tax payments effectively act as an added tax-free gift, because the trust grows without being reduced by income taxes.
When Trust Planning Actually Pays Off
For someone with a $5 million estate in a state with no estate or inheritance tax, the federal exemption already covers everything. An irrevocable trust adds legal fees, complexity, and loss of control for no tax benefit. A revocable trust for probate avoidance may still be worth it, but that is convenience rather than tax planning.
The math shifts in a few specific situations. If your estate exceeds $15 million on your own, or $30 million as a couple, irrevocable trusts become central to keeping the excess out of the 40% federal rate. If you live in a state with its own estate tax at a lower threshold, planning can pay off at much smaller estate sizes. If you hold a large life insurance policy, an ILIT is one of the cleanest ways to keep the death benefit out of the taxable estate. And if you own assets with strong appreciation potential, a GRAT can shift that growth to the next generation while using little or none of your lifetime exemption.
The trade-offs are real. You lose the step-up in basis on assets you remove from your estate. You lose control over what you transfer. And undistributed trust income runs into the top individual rate almost immediately. The right call depends on the size of your estate, the state you live in, the kinds of assets you hold, and how much control you are willing to give up.