What Type of Trust Actually Avoids Inheritance Tax? + FAQs

Lana Dolyna, EA, CTC

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The type of trust that avoids inheritance tax is an irrevocable trust. A revocable living trust does not, because you still own and control everything in it.

That is the mistake in the title. Many people set up a revocable living trust and assume it cuts death taxes. A revocable trust is still the trust that avoids probate, but the tax bill stays the same.

An irrevocable trust works because you give up ownership. Assets you properly move out stay out of your estate. There is a catch. Putting assets into the trust is a gift. That gift uses up part of your lifetime exemption unless it fits within the annual gift exclusion.

Check your exposure before you pay for a trust. There is no federal inheritance tax. The federal estate tax reaches only estates above the basic exclusion amount, which is $15,480,000 per person for deaths in 2027 and $15,000,000 for deaths in 2026. Only five states charge an inheritance tax. If your estate is smaller and you live elsewhere, a complex trust may save you nothing.

Estate Tax vs. Inheritance Tax: Know the Difference

People call both of these "death taxes," but they work in different ways.

Estate tax: a tax on the total value of your estate before it goes to heirs. The estate pays it. Federal rates run from 18% to 40%, and 12 states plus the District of Columbia have their own.
Inheritance tax: a tax on what each beneficiary receives. The heir is the one who owes it. There is no federal inheritance tax. Five states charge one: Pennsylvania, New Jersey, Nebraska, Kentucky and Maryland.

Maryland has both taxes. Iowa's inheritance tax does not apply to deaths on or after January 1, 2025. An estate tax applies only to the amount above the exemption. An inheritance tax usually charges close relatives a lower rate, or nothing, and distant heirs more.

Here is how the two differ on a $5 million estate in a state with both taxes. Assume, for illustration only, a $3 million state estate tax exemption.

Under the estate tax, the executor owes tax on the $2 million above the exemption.
Under the inheritance tax, each heir owes tax on their own share. A child might pay 5%, while a non-relative might pay three times that rate.

Estate tax comes out of the total before anyone inherits. Inheritance tax is charged to each person after they inherit. Trust planning can reduce both.

How Trusts Shield Your Wealth from Taxes (Federal Law)

When you place assets in an irrevocable trust, they belong to the trust, not to you. A trustee manages them for the beneficiaries you name. Because you no longer own or control the assets, they are generally not counted in your estate when you die.

The federal estate tax applies only above a high threshold. The One Big Beautiful Bill Act (Public Law 119-21), signed July 4, 2025, made a $15,000,000 base exclusion permanent starting in 2026 and indexed it for inflation. For deaths in 2027, the IRS has set the exclusion at $15,480,000 per person. Amounts above the exclusion are taxed at the top federal rate.

Married couples can use two exemptions through a rule called portability. The executor must file Form 706 within 9 months of the death, or 15 months with an extension. An executor who files only to elect portability and misses that date can still file up to 5 years after the death under Revenue Procedure 2022-32.

A gift to an irrevocable trust does not erase tax by itself. Say you own $18 million in 2027 and give $3 million to a trust. The gift uses $3 million of your lifetime exemption. At death, it is added back to the tax calculation as an adjusted taxable gift. The saving is in the growth. If the $3 million grows to $6 million before you die, that $3 million of growth is never taxed. At the 40% top rate, your family keeps $1.2 million more. Gifts that fit the annual exclusion also leave your estate without using any exemption.

A separate generation-skipping transfer (GST) tax applies when wealth skips a generation, such as a gift straight to grandchildren. The GST exemption always equals the basic exclusion for the same year. Dynasty trusts use it so assets can pass to grandchildren and beyond without tax at each generation. Trusts can also make sure both spouses' exemptions are fully used, which a simple will might not do.

Federal Estate, Gift and GST Tax Figures: 2026 vs. 2027

Figure	2026	2027
Basic exclusion amount (estate and gift), per person	$15,000,000	$15,480,000
GST exemption, per person	$15,000,000	$15,480,000
Annual gift exclusion, per recipient	$19,000	$20,000
Annual exclusion for gifts to a non-citizen spouse	$194,000	$201,000
Top estate, gift and GST tax rate	40%	40%

The 2026 figures come from Revenue Procedure 2025-32. The 2027 figures come from Revenue Procedure 2026-35, which the Internal Revenue Service (IRS) released on November 5, 2026.

Types of Trusts That Avoid Inheritance Tax (Estate Tax Avoidance Trusts)

Not every trust saves tax. The trusts below are all irrevocable, and funding one is usually a gift you must report. Here is how each one works.

Irrevocable Life Insurance Trust (ILIT) – Sheltering Your Policy Payout

An irrevocable life insurance trust (ILIT) owns your life insurance policy so the payout is not counted in your estate. If you own a large policy yourself, the full death benefit is added to your estate. With an ILIT, the trust owns the policy. When you die, the proceeds go to the trust and then to your beneficiaries, outside your estate. Life insurance is already free of income tax. The ILIT makes it free of estate tax too.

Three rules decide whether it works:

Three-year rule: if you transfer a policy you already own and die within 3 years, the proceeds come back into your estate under tax code section 2035. Having the trust buy a new policy avoids this.
Premiums: you pay them by making gifts to the trust. The trustee sends the beneficiaries Crummey withdrawal notices so each gift qualifies for the annual exclusion.
Control: use an independent trustee and keep no "incidents of ownership" under section 2042, such as the right to change beneficiaries or borrow against the policy.

Bypass Trust (Credit Shelter Trust) – Double Your Exemption

A bypass trust, also called a credit shelter trust, lets a married couple use both estate tax exemptions. When the first spouse dies, an amount up to that spouse's exemption goes into an irrevocable trust instead of straight to the survivor. The survivor can usually receive income for life, and principal under set conditions. The trust assets are not counted in the survivor's estate. At the second death, the trust passes to the children free of estate tax. Many couples write this trust into a will, which makes it one of the common types of testamentary trusts in use.

Portability now does part of this job. The executor elects it on Form 706, and the survivor keeps the deceased spouse's unused exclusion. Either way, a couple can shelter up to $30,960,000 combined in 2027, or $30,000,000 in 2026.

A bypass trust still matters for four reasons:

Growth inside the trust after the first death escapes estate tax. The unused exclusion carried over by portability is frozen and is not indexed for inflation.
Most state estate taxes do not allow portability.
The first spouse decides where the money ends up, which protects children in blended families.
A survivor who remarries can lose the first spouse's unused exclusion. A funded trust cannot be lost that way.

The trade-off is basis. Assets in the bypass trust get no second step-up in basis when the survivor dies, so heirs may owe more capital gains tax when they sell.

Grantor Retained Annuity Trust (GRAT) – Let Assets Grow Tax-Free

A grantor retained annuity trust (GRAT) passes an asset's future growth to your heirs at little or no gift tax cost. You put in assets that are likely to rise in value, such as stock or a business interest. The trust pays you an annuity for a set term, often 2 to 10 years. The payments are set to return what you put in plus an assumed rate of return. That makes the taxable gift close to $0, which planners call a zeroed-out GRAT.

The assumed return is the section 7520 rate. It equals 120% of the federal mid-term rate, and the IRS publishes it each month on its website. Growth above that hurdle stays in the trust for your heirs. If the assets fall short, they simply come back to you through the annuity payments.

Here is an example. You put $5 million of stock into a 5-year GRAT. Over the term, the trust pays you back about $5 million plus the section 7520 return. The stock does well, and the trust is worth about $8 million in total over those years. After your payments, roughly $3 million is left for your heirs, with almost no gift exemption used.

You must outlive the term. If you die during it, most or all of the trust assets are pulled back into your estate. GRATs are a long-established technique that the tax code itself provides for in section 2702.

Dynasty Trust (Generation-Skipping Trust) – Legacy for Generations

A dynasty trust passes wealth down several generations without estate tax at each death. You fund an irrevocable trust and allocate your GST exemption to the gift on Form 709, the gift tax return. The GST exemption matches the estate tax exemption for 2026 and for 2027, as the table above shows. It is now permanent under Public Law 119-21 and indexed for inflation.

The trust then benefits your children, grandchildren and later heirs. The assets are not included in anyone's estate when a beneficiary dies. A large gift today could grow many times over, and none of that growth is taxed as it passes down. The details of how a dynasty trust avoids the generation-skipping tax depend on that Form 709 allocation. Families choosing a trust for grandchildren often start here.

Two limits apply. First, how long the trust can last depends on state perpetuities law. Some states allow a trust to run for centuries or forever, and others cap the term. Second, income tax still applies. A trust reaches the top federal income tax bracket at a very low income level, far below where a person does. Some online courses claim an irrevocable trust makes income tax disappear. It does not. The trust pays tax on income it keeps, and beneficiaries pay tax on income it hands out.

Spousal Lifetime Access Trust (SLAT) – Use Your Exemption While Keeping Indirect Access

A spousal lifetime access trust (SLAT) is an irrevocable trust you create for your spouse, and often for your children too. You fund it with a gift that uses your lifetime exemption. The assets and all their later growth leave both spouses' estates. Your spouse can still receive distributions, so the household keeps indirect access to the money.

A SLAT carries three risks:

Divorce: your former spouse keeps the benefit, and you lose your indirect access.
Death of your spouse: your access ends, and the assets move on to the next beneficiaries.
Reciprocal trusts: if both spouses create near-identical SLATs for each other, the IRS can treat each spouse as owning their own trust and pull the assets back into each estate.

Many SLATs are also set up as intentionally defective grantor trusts (IDGTs). With that design, you pay the income tax on the trust's earnings yourself. The trust grows faster, and the tax you pay is not treated as another gift.

Charitable Trusts (CRTs & CLTs) – Give Back and Save Taxes

Charitable trusts support a cause and cut taxes at the same time. Two forms are common:

Charitable remainder trust: the trust pays you, or someone you choose, an income for life or a term of years. What is left goes to charity. Appreciated assets can be sold inside it with no upfront capital gains tax.
Charitable lead trust: the reverse setup. The trust pays a charity for a set term, and the rest goes to your heirs. The charity's payments shrink the taxable value of the gift to your family.

A charitable remainder trust has to meet two tests. It must pay out between 5% and 50% of its value each year. The charity's projected remainder must also be at least 10% of what you put in.

You get an income tax deduction for that projected remainder, but the deduction is worth less than it used to be. Starting in 2026, itemized charitable deductions count only above a floor of 0.5% of adjusted gross income (AGI). From 2026, taxpayers in the 37% bracket also get a benefit worth at most 35 cents per dollar deducted. Both limits come from Public Law 119-21. The estate tax charitable deduction is separate and has no cap. Whatever passes to charity at your death is fully deductible from your estate.

State Inheritance Taxes: Can Trusts Help?

Each inheritance tax state sets its rates by how closely the heir is related to the person who died. Iowa used to be on the list, but its tax ended for deaths on or after January 1, 2025. These are the rules for 2026 deaths.

Pennsylvania charges 0% on transfers to a surviving spouse, 4.5% to children and other lineal heirs, 12% to siblings and 15% to other heirs.
Nebraska, for 2026 deaths, charges close relatives 1% above $100,000 and remote relatives 11% above $40,000. Everyone else pays its top rate above $25,000.
Kentucky exempts a spouse, parents, children, grandchildren and siblings. More distant heirs pay graduated rates that depend on their class.
New Jersey exempts a spouse, children, grandchildren and parents. For 2026 deaths, siblings pay graduated rates above $25,000, and most other heirs get no exemption.
Maryland exempts close family, including siblings, and charges other heirs a flat 10%.

Trusts can help with these taxes in some cases, but the results are limited.

A trust for your spouse delays the tax. All five states exempt a surviving spouse, and charities are exempt too. Leaving assets in trust for a spouse means no tax at the first death. The tax question returns when the assets later pass to other heirs.

Gifts made well before death are generally outside the tax. Timing matters, because two states look back. New Jersey presumes that a transfer made within 3 years of death was made in contemplation of death and taxes it. Under Pennsylvania's 2026 rules, gifts over $3,000 per recipient made within 1 year of death are pulled back. A trust funded on a deathbed does not work in either state.

The trust's location alone will not save you. Stocks, bonds and other intangible assets are taxed by the state where the person lived at death. A New Jersey resident who moves investments into a Delaware trust has not moved them out of reach of New Jersey's tax. Changing your own state of residence is what changes the result.

A trust cannot remove a state's inheritance tax when a taxable heir ends up with the money. It can shift assets to exempt heirs, move assets out early, and control timing. Inheritance tax rates are also much lower than the top federal estate tax rate.

The Five State Inheritance Taxes at a Glance

These are the rates in effect for 2026 deaths, taken from each state's own guidance.

State (2026)	Spouse	Children	Siblings	Unrelated heirs
Pennsylvania	0%	4.5%	12%	15%
New Jersey	Exempt	Exempt	11% to 16% above $25,000	15% to 16%, no exemption
Nebraska	Exempt	1% above $100,000	1% above $100,000	15% above $25,000
Kentucky	Exempt	Exempt	Exempt	6% to 16% above $500
Maryland	Exempt	Exempt	Exempt	10%; shares of $1,000 or less are exempt

The figures come from the Pennsylvania Department of Revenue, the New Jersey Division of Taxation, Nebraska's inheritance tax statute, the Kentucky Department of Revenue and the Maryland Register of Wills. Iowa is not in the table because it repealed its tax for deaths from 2025 on.

Trusts vs. Other Estate Planning Strategies: A Comparison

Trusts are not the only way to lower inheritance or estate taxes. Here is how they compare with other common tools.

Tax year 2027 rules; the dollar limits are in the 2026 vs. 2027 table above.

Strategy (2027)	How It Works	Tax Benefit	Trade-offs
Irrevocable trusts	Transfer assets into a trust and give up ownership and control (ILIT, GRAT, SLAT, dynasty trust)	Removes the assets and their later growth from your taxable estate	Complex setup and legal fees; hard to change; you lose direct control
Annual gifting	Give up to the annual exclusion to each recipient every year; married couples who split gifts can give double	Shrinks your estate each year with no gift tax and no exemption used	You part with the assets outright; larger gifts use lifetime exemption
Large lifetime gifts	Give assets above the annual exclusion, using your lifetime exemption	Moves future growth out of your estate	Uses part of the 2027 exemption; no step-up in basis; cannot be undone
Charitable donations	Give assets to charity directly or through a charitable trust	Donated assets are not taxed in your estate; lifetime gifts may bring an income tax deduction	Assets given to charity do not go to your heirs, except through a charitable trust
Family limited partnership (FLP)	Put assets in a partnership and give or sell limited interests to family at a discount	Lowers the taxable value of gifted interests; later growth builds outside your estate	Needs a formal entity and appraisals; the IRS may challenge the discounts
Revocable living trust	Assets sit in a trust you can change and still control	No estate tax reduction; the assets stay in your estate	Avoids probate and helps manage assets, but saves no tax

Irrevocable trusts are the most direct tool because they take assets out of your ownership. Most plans combine several tools. You might make annual gifts to your children, set up an ILIT for insurance, use a GRAT for business stock and leave some money to charity.

Avoid These Common Trust-Planning Mistakes

A good tool can still fail if it is set up or run badly. These are the errors that cost families the most.

Using the wrong trust type. A revocable living trust will not cut estate tax. Only an irrevocable trust removes assets from your taxable estate.
Keeping control. If you keep too much control or benefit, the IRS can still count the assets in your estate. Use an independent trustee and leave yourself out as a beneficiary.
Skipping the gift tax return. A transfer to an irrevocable trust is usually a gift. Form 709 is due April 15 of the year after the gift.
Forgetting the lost step-up. Under Revenue Ruling 2023-2, assets in an irrevocable grantor trust that stay out of your estate get no step-up in basis at death. Heirs may owe more capital gains tax.
Planning around a drop that never came. The exemption did not fall in 2026. Public Law 119-21 made the $15 million base permanent and indexed. Congress can still change it, and state rules differ.
Thinking a gift uses no exemption. Lifetime gifts are added back as adjusted taxable gifts. Only the growth after the gift and annual exclusion amounts truly escape.
Doing it yourself. Small errors in wording or administration can undo the tax benefit. An experienced estate planning attorney should set up and oversee complex trusts.

Is an Irrevocable Trust Worth It If Your Estate Is Under the Exemption?

Often it is not. If your estate is below the 2027 exemption, the federal estate tax saving from a trust is $0. The cost can be real, though. Assets you move out of your estate lose the step-up in basis that heirs get on inherited property.

Here is a short comparison using 2027 rules. Maria is a widow with a $3 million estate in 2027. It includes stock she bought for $200,000 that is now worth $1,000,000.

In the first case, she keeps the stock until she dies in 2027. Her estate owes no federal estate tax. Her children's basis steps up to $1,000,000. They sell and owe no capital gains tax.

In the second case, she gives the stock to an irrevocable trust that stays out of her estate. The 2027 estate tax saving is still $0. The basis stays at $200,000. A sale creates an $800,000 gain, and the federal capital gains tax on it could reach $120,000 or more.

The trust saved Maria's family nothing and cost them a six-figure tax bill.

An irrevocable trust can still make sense for a smaller estate in four situations:

You live in a state with its own estate tax or inheritance tax, where the exemption is far lower.
You are planning for Medicaid and need to know whether a trust counts as an asset under those rules.
You want to protect assets from creditors or lawsuits.
You have a blended family and want to fix who inherits after your spouse.

If none of these apply, a simpler plan may serve you better. Start by deciding which trust to set up based on your goal, not on a tax you may never owe.

What the Main Estate and Inheritance Tax Terms Mean

These are the terms you will see in any plan or attorney's letter.

Estate tax: a tax on the total value of a person's estate at death, before it is distributed. The federal tax applies only above the exemption.
Inheritance tax: a state tax on the amount an heir receives. The beneficiary owes it, and close relatives often pay less or nothing.
Exemption: the part of an estate that is free of estate tax. With the 2027 exemption, a $17 million estate is taxed only on $1,520,000.
Irrevocable trust: a trust the creator (the grantor) generally cannot change or cancel. Because the grantor gives up control, the assets are usually excluded from the estate.
Revocable trust: a trust the grantor can change or cancel during life. The assets stay in the grantor's estate, so there is no tax benefit.
Gift tax: a federal tax on large lifetime gifts. It shares one lifetime exemption with the estate tax.
Annual exclusion: the amount you can give each person per year without using any lifetime exemption. It rises with inflation.
Step-up in basis: the reset of an inherited asset's cost basis to its value at death. Assets removed from your estate by gift or by some trusts do not get it.
Generation-skipping transfer (GST) tax: an extra flat tax on transfers to grandchildren and other "skip" persons. Its exemption matches the estate tax exemption.
Portability: the election, made on Form 706, that lets a surviving spouse use the deceased spouse's unused exclusion amount.
Adjusted taxable gifts: lifetime gifts above the annual exclusion. They are added back when the estate tax is figured, so they use up exemption.

Real-Life Examples: Trusts in Action

The two examples below show the math. Both use 2027 figures and are simplified.

Example 1: Cutting the Estate Tax on a $20M Estate

Jane has a $20 million estate. It includes a $3 million life insurance policy and $17 million of other assets. With the 2027 exemption of $15,480,000, doing nothing leaves $4,520,000 taxable. At 40%, the tax is about $1.81 million.

Her first step is an ILIT. The trust buys a new $3 million policy, and Jane pays the premiums with annual exclusion gifts. The insurance is now outside her estate. That leaves $17 million, with $1,520,000 taxable under the 2027 exemption.

Her second step is a $4 million gift to a dynasty trust. The gift uses $4 million of her 2027 exemption and leaves $11,480,000. By the time she dies, the trust has grown to $8 million. Her own estate holds $13 million. Subtract the $11,480,000 of exemption she has left, and $1,520,000 is taxable. The tax is about $608,000.

The gift itself did not lower the taxable amount. What escaped tax is the $3 million of insurance and the $4 million of growth inside the trust. Without any planning, her estate would have reached $24 million and owed about $3.41 million on 2027 figures. The final figure is a simplified estimate. It assumes no growth in her other assets. The assets she gave away also get no step-up in basis.

Example 2: Using a GRAT to Transfer Future Growth

Raj owns a business worth $10 million. He expects it to reach $30 million. If he keeps it until death, the 2027 exemption of $15,480,000 leaves $14,520,000 taxable. At 40%, the tax is about $5.8 million in this simplified case.

Instead, Raj puts the business interest into a zeroed-out 5-year GRAT in 2027, while it is valued at $10 million. Over the 5 years, the trust pays him back about $10 million plus the section 7520 return. He uses almost no gift exemption. If the business does reach $30 million, the growth above those payments passes to his children outside his estate. That could be $15 million or more.

Raj has to outlive the 5-year term. If he dies during it, most of the trust's value returns to his estate and the plan fails. The annuity payments he received also stay in his estate.

Evidence: Do Trusts Really Work?

Yes, when the trust matches the tax you actually face.

Well over 99% of estates owe no federal estate tax. The main reason is the high 2027 exemption, not trusts.
For estates above that line, ILITs, GRATs and dynasty trusts are long-established techniques that the tax code and IRS rulings recognize.

A properly run trust plan keeps wealth in the family that would otherwise go to tax. A trust aimed at a tax you do not owe only adds cost.

Protect Your Legacy with Smart Trust Planning

Estate and inheritance taxes can be reduced, and sometimes removed, with early planning. Irrevocable trusts are the main tool because they move assets out of your taxable estate. An ILIT handles life insurance. A GRAT handles fast-growing assets. A dynasty trust handles wealth meant for later generations. Lifetime gifts, charitable giving and family partnerships work alongside them.

Before you pay for a complex trust, check two things. See whether your estate is near the 2027 exemption. Then see whether you or your heirs live in an inheritance tax state. If neither applies, the trust may cost more than it saves.

What to do next

Add up your estate, including life insurance death benefits, and compare the total with the 2027 exemption.
Check whether you or your heirs live in one of the five inheritance tax states.
Look at who owns each life insurance policy. If you own it, ask an attorney about an ILIT.
List your low-basis assets before you give anything away, so you can weigh the lost step-up.
File Form 709 by April 15 for any trust gift above the annual exclusion or without Crummey powers.

FAQs: Your Inheritance Tax and Trust Questions Answered

What is the best trust to avoid inheritance tax?

An irrevocable trust. The main types are an ILIT for life insurance, a dynasty (GST) trust, a SLAT, a GRAT and charitable trusts. The best one depends on the asset and on which tax you face: federal estate tax, state estate tax or state inheritance tax.

Do revocable living trusts help reduce estate or inheritance taxes?

No. You still control the assets, so they stay in your taxable estate. A revocable trust still avoids probate and helps manage your assets. Only an irrevocable trust removes assets for tax purposes.

Which states have an inheritance tax?

Five states: Pennsylvania, New Jersey, Nebraska, Kentucky and Maryland. Maryland also has an estate tax. Iowa repealed its inheritance tax for deaths on or after January 1, 2025. Close relatives usually pay a lower rate or nothing.

Is money I inherit from a trust taxable income to me?

Inherited principal is not income. Trust income paid out to you, known as distributable net income, is taxed to you and reported on Schedule K-1 (Form 1041). Inherited retirement accounts held in a trust are taxed as money is withdrawn. State inheritance tax is legally the beneficiary's bill, though the estate often pays it.

How much can I gift without paying taxes?

For 2027, you can give $20,000 per recipient ($19,000 for 2026). Larger gifts require Form 709 and use your lifetime exemption, which is $15,480,000 for 2027 ($15,000,000 for 2026). Gifts to a spouse who is not a U.S. citizen have a $201,000 annual exclusion in 2027 ($194,000 in 2026).

What is a generation-skipping trust?

It is an irrevocable trust, also called a dynasty trust, that lets wealth pass to grandchildren and later generations without estate tax at each level. It uses your GST exemption, which equals the estate tax exemption for the year.

Can I use a trust to avoid state estate taxes?

Yes. A bypass trust can use both spouses' state exemptions. Most state estate taxes do not allow portability, so the trust still matters there. Lifetime gifts can also cut what your state taxes.

Will inheritance tax laws change soon?

The exemption did not drop in 2026. A law signed July 4, 2025 set a permanent $15 million base for 2026, indexed for inflation in later years. Permanent only means there is no built-in end date. A future Congress can change it, and states keep changing their laws, as Iowa did. Review your plan regularly.

What is the federal estate tax exemption for 2027?

It is $15,480,000 per person for deaths in 2027, up from $15,000,000 for 2026. A married couple can shelter $30,960,000 in 2027 using portability or a bypass trust. The figures come from Revenue Procedure 2026-35.

Do assets in an irrevocable trust get a step-up in basis?

Generally no, when the trust is kept out of your estate. Revenue Ruling 2023-2 confirms it. The exception is a trust designed to be included in the estate, for example through a general power of appointment.