What Is Estate and Gift Tax Planning?

What Is Estate and Gift Tax Planning?

Every Vermont resident with a substantial estate needs to understand how federal and Vermont estate and gift taxes work, and how strategic planning can dramatically reduce or eliminate the tax burden on their family. Estate and gift tax planning is the legal process of structuring the ownership and transfer of your assets in a way that minimizes tax liability while ensuring your wealth passes to your chosen beneficiaries as efficiently as possible.

The two taxes that matter most in this context are the federal gift tax, which applies to transfers of property made during your lifetime, and the federal estate tax, which applies to transfers that take effect at your death. Vermont also imposes its own separate state estate tax. Understanding how these taxes interact, and how to use the available exemptions, deductions, and planning tools to your advantage, is the foundation of sound estate planning for larger Vermont estates.

What is the federal estate tax, and who does it affect in Vermont?

The federal estate tax is a tax on the transfer of your taxable estate at death. When you die, everything you own at the time of your death becomes part of your gross estate, including personal property such as vehicles and household items, liquid assets such as savings accounts and investment accounts, real estate, retirement accounts, and life insurance proceeds.

Life insurance proceeds, while not taxed as income to the recipient, are included in the calculation of your gross estate for federal estate tax purposes.

Your taxable estate equals your gross estate minus funeral and burial expenses paid from the estate, debts owed at the time of death, the value of property transferred to a surviving U.S. citizen spouse, the value of property transferred to a qualifying charity, and state death taxes paid.

What is the federal estate tax exemption in 2026?

In 2026, the federal unified credit, the amount each person can transfer free of federal estate tax, is $15,000,000 per person, permanently set at that level by the One Big Beautiful Bill Act (P.L. 119-21), signed into law on July 4, 2025. This means the first $15,000,000 of each person's estate is fully shielded from federal estate tax.

If an estate exceeds $15,000,000, federal estate tax is owed on the excess at rates up to 40%. Beginning in 2027, the exemption is inflation-indexed and will increase annually to keep pace with inflation.

What is the Vermont estate tax, and how does it differ from the federal tax?

Vermont imposes its own separate state estate tax under 32 V.S.A. § 7442a. Vermont assesses a 16% estate tax on all assets over $5,000,000. This means a Vermont estate can owe Vermont estate tax even when it owes no federal estate tax, because Vermont's $5,000,000 threshold is significantly lower than the federal $15,000,000 exemption.

For Vermont residents with estates between $5,000,000 and $15,000,000, Vermont estate tax planning is particularly important. The federal exemption fully shields them from federal tax, while Vermont's lower threshold exposes a significant portion of the estate to state-level taxation.

What is the unified credit, and how does it work?

The unified credit is a tax credit that applies against the gift or estate tax that would otherwise be owed on transfers of your property. In 2026, each person has a unified credit that shelters $15,000,000 from the federal gift and estate tax combined. This credit is “unified” because it applies to both lifetime gifts and transfers at death as a single combined exemption. Gifts made during your lifetime that exceed the annual exclusion reduce your remaining estate tax exemption at death. If your total lifetime taxable gifts and estate are below $15,000,000, no federal gift or estate tax is owed.

What is portability, and how does it help married couples?

Federal portability allows a surviving spouse to use the unused portion of their deceased spouse's federal unified credit in addition to their own. A married couple can combine their unified credits in 2026 to shelter up to $30,000,000 from federal estate tax, provided the portability election is timely made on the first spouse's federal estate tax return (Form 706), even if no estate tax is otherwise due.

Portability must be elected. It is not automatic. Missing the portability election deadline can permanently forfeit the deceased spouse's unused exemption, potentially resulting in a substantial and entirely avoidable estate tax bill at the surviving spouse's death.

Vermont does not have a portability provision. Each spouse's Vermont exemption must be used independently.

What is the unlimited marital deduction?

Under federal tax law, one spouse can give an unlimited amount of property to a U.S. citizen spouse, either during their lifetime or at death, with no estate or gift tax consequence. This is known as the Unlimited Marital Deduction. It means a spouse can leave their entire estate to a surviving U.S. citizen spouse completely free of federal estate tax.

However, the unlimited marital deduction only defers the tax. When the surviving spouse later dies, only their own $15,000,000 exemption, plus any ported exemption, is available to shelter the combined estate. For large estates, simply leaving everything to a surviving spouse and relying on the marital deduction can waste the first spouse's exemption and create a significant tax bill at the second death.

What happens if a married couple does no estate tax planning in Vermont?

Consider a Vermont couple where the husband has a taxable estate of $16,000,000 and the wife has assets of $14,000,000, a combined estate of $30,000,000. If the husband dies first with a simple will leaving everything to his wife, the transfer is entirely tax-free under the unlimited marital deduction. The wife now owns the entire $30,000,000 estate.

When the wife dies, her $15,000,000 unified credit shelters the first $15,000,000. However, the remaining $15,000,000 is fully exposed to federal estate tax at rates up to 40%, producing an estimated federal estate tax bill of $4,800,000 to $6,000,000 or more. The husband's $15,000,000 unified credit was permanently and completely wasted. A Vermont estate tax liability on assets above $5,000,000 would also apply separately.

What is a Credit Shelter Trust, and how does it eliminate estate tax for married couples?

A Credit Shelter Trust, also called a Bypass Trust or A/B Trust, is a trust designed to ensure that both spouses' federal unified credits are fully utilized, rather than allowing one spouse's credit to be wasted.

Using the same couple described above, the husband's will or trust directs that $15,000,000 flows into a Credit Shelter Trust for the benefit of his children, with the remaining $1,000,000 passing outright to his wife. The $1,000,000 passing to the wife is protected by the unlimited marital deduction. The $15,000,000 placed in trust is treated as a gift to the children and is fully shielded from estate tax by the husband's unified credit. The wife has access to trust income and limited access to principal during her lifetime.

When the wife dies, the $15,000,000 in the Credit Shelter Trust passes to the children completely estate-tax-free. The wife's own estate, her $14,000,000 in separate assets plus the $1,000,000 she received outright, totals $15,000,000, which is fully sheltered by her own unified credit.

The result: the entire $30,000,000 passes to the children with zero federal estate tax, compared to a tax bill of $4,800,000 to $6,000,000 or more with no planning. Both spouses' $15,000,000 unified credits were fully utilized.

What is the annual gift tax exclusion, and how can it reduce my Vermont estate?

In 2026, the annual gift tax exclusion is $19,000 per recipient. A married couple can combine their annual exclusions and gift $38,000 per recipient per year completely gift-tax-free to any number of individuals. These gifts reduce the value of your taxable estate each year without using any of your $15,000,000 lifetime unified credit.

In addition to the annual exclusion, amounts paid directly to a qualified educational institution for tuition or directly to a medical provider for healthcare expenses are completely nontaxable, with no dollar limit, and do not count against the annual exclusion or lifetime exemption.

Can I make annual exclusion gifts to a trust?

Annual exclusion gifts can be made to a trust, but only if the trust includes specific provisions known as Crummey powers, named after a landmark tax case, that give each beneficiary a temporary right to withdraw their share of the annual gift within a defined window, typically 30 days. Without these withdrawal rights, the IRS does not treat the gift as a completed present-interest gift qualifying for the annual exclusion. Properly drafted Crummey powers allow annual exclusion gifts to flow into a trust while preserving the gift tax exclusion, making them an important drafting consideration for irrevocable trusts designed to receive ongoing gifts.

What is a Qualified Terminal Interest Property (QTIP) Trust?

A QTIP Trust is a specific type of marital trust that qualifies for the unlimited marital deduction while allowing the first spouse to control who ultimately receives the trust assets after the surviving spouse's death. The surviving spouse must receive all income from the trust at least annually, and the executor elects QTIP treatment on the estate tax return.

QTIP trusts are particularly valuable for blended families where the first spouse wants to provide for the surviving spouse during their lifetime while ensuring that the remaining trust assets ultimately pass to children from a prior relationship rather than to the surviving spouse's heirs. Vermont QTIP planning must coordinate both federal and Vermont estate tax treatment.

What is an Irrevocable Life Insurance Trust (ILIT) and why is it used in estate planning?

An Irrevocable Life Insurance Trust is a trust that owns a life insurance policy rather than having the policy owned by the insured individually. Because the trust, not the insured, owns the policy, the life insurance proceeds are excluded from the insured's gross estate and are not subject to estate tax.

In large taxable estates, the tax-free cash proceeds can be used to pay federal and Vermont estate taxes without forcing the sale of other estate assets. ILITs are particularly valuable for family-owned Vermont businesses, where the insurance proceeds can fund a buy-sell agreement, create liquidity to continue the business, or allow family members to purchase each other's interests without disrupting business operations.

What is an Intentionally Defective Grantor Trust (IDGT)?

An Intentionally Defective Grantor Trust is a sophisticated estate planning tool that removes assets from the grantor's taxable estate for estate tax purposes while keeping the trust assets taxable to the grantor for income tax purposes. This “defect” is intentional and highly beneficial: the grantor pays income tax on trust earnings, which further reduces the taxable estate without being treated as an additional taxable gift to the beneficiaries.

The grantor can either gift assets to the IDGT or sell assets to it in an installment sale, often at a discount using a Family Limited Partnership or LLC structure, allowing any future appreciation in the transferred assets to grow entirely outside the taxable estate. IDGTs are among the most powerful estate tax planning tools available for high-net-worth Vermont families.

What is a Spousal Limited Access Trust (SLAT)?

A Spousal Limited Access Trust is an irrevocable trust that allows one spouse, the donor spouse, to transfer assets out of their taxable estate while the other spouse, the beneficiary spouse, retains indirect access to the trust assets. Because the transfer to the SLAT is a completed gift, the assets and all future appreciation are removed from the donor spouse's taxable estate. The beneficiary spouse can receive distributions for health, education, maintenance, and support.

A critical planning consideration is the reciprocal trust doctrine. If both spouses create nearly identical SLATs for each other, the IRS may treat the trusts as reciprocal and pull the assets back into each spouse's taxable estate. Careful drafting and timing are essential.

What is a Grantor Retained Annuity Trust (GRAT)?

A Grantor Retained Annuity Trust is an irrevocable trust that allows a grantor to transfer assets to family members with little or no gift tax cost. The grantor transfers assets into the GRAT and retains the right to receive a fixed annuity payment for a specified term of years. At the end of the term, any remaining assets, including all appreciation above a hurdle rate set by the IRS, pass to the named beneficiaries estate-tax-free without using any of the grantor's lifetime gift tax exemption.

GRATs work best when funded with assets expected to appreciate significantly, such as closely held business interests, investment portfolios, or real estate, and when interest rates are low. The primary risk is that the grantor must survive the trust term for the GRAT to achieve its tax benefits.

What is a Qualified Personal Residence Trust (QPRT)?

A Qualified Personal Residence Trust is an irrevocable trust used to transfer a personal residence or vacation home out of a grantor's taxable estate at a significantly reduced gift tax cost. The grantor transfers the home to the QPRT but retains the right to live in it for a specified term of years. At the end of the term, ownership passes to the grantor's children or other named beneficiaries.

The taxable gift is calculated at a discount because the IRS accounts for the grantor's retained right to use the home during the trust term. The exact discount depends on three specific variables: the grantor's age at the time the QPRT is funded, the length of the trust term selected, and the Section 7520 rate in effect during the month the QPRT is established. Any appreciation in the property after the transfer grows entirely outside the taxable estate. As with GRATs, the grantor must survive the trust term for the QPRT to achieve its intended tax benefit.

What is a Charitable Remainder Trust (CRT)?

A Charitable Remainder Trust is a tax-exempt irrevocable trust that provides income to the grantor or other named beneficiaries for a specified period, either a term of years or the beneficiary's lifetime, with the remaining trust assets ultimately passing to one or more charitable organizations.

A CRT allows the grantor to contribute highly appreciated assets to the trust, receive an immediate charitable income tax deduction for the present value of the remainder interest passing to charity, avoid immediate capital gains tax on the sale of appreciated assets within the trust, receive a stream of income during the trust term, and reduce the size of the taxable estate. CRTs are powerful tools for Vermont residents who hold highly appreciated real estate, business interests, or investment assets and want to generate retirement income while supporting charitable causes.

What is a Charitable Lead Trust (CLT)?

A Charitable Lead Trust is the mirror image of a Charitable Remainder Trust. In a CLT, a charitable organization receives income payments from the trust for a specified period, and the remaining assets pass to non-charitable beneficiaries, such as children or grandchildren, at the end of the term.

CLTs are used to reduce estate and gift taxes on assets transferred to the next generation by giving the IRS credit for the income stream paid to charity during the trust term, which reduces the taxable value of the gift to family members. CLTs are particularly effective in low-interest-rate environments and for families with strong charitable intentions who also want to transfer wealth to the next generation at a reduced tax cost.

What is a Generation-Skipping Transfer (GST) Trust?

A Generation-Skipping Transfer Trust is a trust designed to pass wealth directly to grandchildren or later generations, skipping the children's generation, while minimizing or avoiding the generation-skipping transfer tax, which is imposed in addition to the estate tax on transfers that skip a generation. Each person has a GST exemption of $15,000,000 in 2026, the same amount as the federal unified credit, that can be allocated to transfers to a GST trust.

The GST exemption and the unified credit are separate exemptions that must each be separately tracked and allocated. Assets in a properly structured GST trust can benefit multiple generations without being subject to estate tax at each generational level. GST planning is among the most complex areas of estate tax law and requires careful coordination between federal and Vermont tax considerations.

How do Family Limited Partnerships and LLCs reduce estate taxes in Vermont?

Family Limited Partnerships and Family LLCs allow Vermont families to transfer business interests, investment assets, or real estate to younger family members at a discounted value for gift and estate tax purposes. Because limited partnership interests and minority LLC membership interests carry transfer restrictions and lack independent management rights and marketability, the IRS permits valuation discounts, typically ranging from 25% to 45%, on the value of those interests for gift and estate tax purposes.

This means a $1,000,000 limited partnership interest may be valued at $600,000 to $750,000 for gift tax purposes, allowing the general partner to gift or sell discounted interests to children and grandchildren over time using the $19,000 annual exclusion and the $15,000,000 lifetime exemption more efficiently. Combined with centralized family asset management and asset protection benefits, FLPs and family LLCs are among the most versatile estate planning tools available to Vermont families with significant real estate or investment portfolios.

What is a Credit Shelter Trust versus a QTIP Trust, and which do I need?

A Credit Shelter Trust, also called a Bypass or A/B Trust, is designed to use the first spouse's federal unified credit by directing assets into a trust for the benefit of children or other beneficiaries, with the surviving spouse having limited access to income and principal. It does not qualify for the unlimited marital deduction but is fully shielded from estate tax by the deceased spouse's unified credit.

A QTIP Trust qualifies for the unlimited marital deduction, meaning the assets are not taxed at the first spouse's death, but the assets are included in the surviving spouse's taxable estate at their death. A QTIP trust gives the first spouse to die control over who ultimately receives the trust assets while providing for the surviving spouse during their lifetime.

The right choice between these structures depends on the size of your combined estate, whether a Vermont estate tax liability exists, your family situation, and your goals for the surviving spouse's access to and control over the assets. Many Vermont estate plans use a combination of both structures.

When should I start estate tax planning in Vermont?

The best time to start estate tax planning is well before your estate approaches the applicable tax thresholds, both federal and Vermont. Many of the most powerful strategies, such as GRATs, QPRTs, IDGTs, SLATs, and Family Limited Partnerships, require assets to appreciate after the transfer for maximum benefit, meaning the earlier the transfer occurs, the greater the potential tax savings.

Annual gifting programs take years to meaningfully reduce a large estate. Life insurance trusts must be established before a policy is acquired or transferred to avoid the three-year lookback rule that would pull insurance proceeds back into the taxable estate. And Medicaid planning, which operates under entirely separate rules with a five-year lookback period, must also be coordinated with estate tax planning to avoid strategies that solve one problem while creating another.

If your estate is approaching $5,000,000, Vermont's estate tax threshold, or $15,000,000, the federal threshold, consult an estate planning attorney now.

Estate and gift tax planning is among the most technically complex areas of estate planning law, requiring coordination of federal tax law, Vermont state tax law, trust law, business entity law, and your personal financial and family situation. The strategies described on this page, including Credit Shelter Trusts, ILITs, IDGTs, SLATs, GRATs, QPRTs, Family Limited Partnerships, and charitable trusts, are powerful tools when properly designed and implemented. They can also create significant problems when used incorrectly or without proper coordination with your overall estate plan.

Attorney Nicole McPhee has been helping Vermont families with complex estate planning for more than 28 years. Whether your estate is approaching the Vermont or federal tax threshold, or you are looking for strategies to maximize the wealth you transfer to the next generation, Will and Trust Planning provides experienced, personalized legal guidance with statewide Vermont service.

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For personalized advice on estate planning, including strategies to minimize or avoid probate, contact Will and Trust Planning today. Our experienced estate planning attorneys can help you understand your options, draft essential documents, and create a plan that protects your assets and achieves your goals.