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Why this topic matters
Taxation and Regulation (REG) Area V covers the unified transfer tax system — gift tax and estate tax — and the income taxation of trusts and estates (fiduciary income tax). The One Big Beautiful Bill Act (OBBBA) made the higher exemption permanent at $15 million per person from 2026, removing the scheduled cut that had dominated planning.
The unified transfer tax system
- Lifetime taxable gifts and transfers at death share one basic exclusion amount: $15,000,000 per individual for 2026 ($30 million for a married couple), indexed for inflation from 2027 — with no sunset.
- The top gift and estate tax rate is 40%.
- Taxable gifts reduce the exclusion available at death; estate tax is computed on the taxable estate plus adjusted taxable gifts, less gift tax payable and the unified credit.
Gift tax
What is a gift?
A transfer for less than adequate consideration, with donative intent not required. A gift is complete when the donor gives up dominion and control. Transfers to a revocable trust, and loans at market interest, are not completed gifts.
Exclusions and deductions
| Item | Rule |
|---|---|
| Annual exclusion | $19,000 per donee per year (2026) — only for gifts of a present interest (a future interest, such as a remainder, doesn't qualify; gifts to a trust qualify only with withdrawal (Crummey) powers). Contributions to a Section 529 plan can be spread over 5 years. |
| Gift splitting | Married couples may elect to treat a gift by one spouse as made half by each — doubling the annual exclusion to $38,000 per donee. Requires consent of both on Form 709. |
| Tuition and medical payments | Unlimited exclusion if paid directly to the school (tuition only, not books or room and board) or medical provider. |
| Marital deduction | Unlimited for gifts to a US-citizen spouse. For a non-citizen spouse, a special annual exclusion applies ($194,000 in 2026). |
| Charitable deduction | Unlimited |
| Political organizations | Excluded |
- Form 709 is due April 15 of the following year (extended with the income tax return). It must be filed for gifts above the annual exclusion, gifts of future interests, and to elect gift splitting — even when no tax is owed.
- The donee takes the donor's basis (see the Basis topic) — so gifting appreciated property passes the built-in gain to the donee.
EXAMPLE: In 2026 a grandparent pays a grandchild's $30,000 tuition directly to the university and gives the grandchild $25,000 cash. The tuition is fully excluded. The cash uses the $19,000 annual exclusion, leaving a $6,000 taxable gift that reduces the lifetime exclusion — no tax is paid, but Form 709 must be filed.
Estate tax
| Estate tax computation |
|---|
| Gross estate: all property owned at death (at fair market value (FMV)), including half of jointly held property with a spouse, life insurance the decedent owned or that is payable to the estate, retirement accounts, revocable trusts, and certain transfers within 3 years of death (such as life insurance policies) |
| − Deductions: funeral and administration expenses, debts, casualty losses during administration, unlimited marital deduction, unlimited charitable deduction, state death taxes |
| = Taxable estate + adjusted taxable gifts (post-1976) |
| × Tax rates − gift taxes payable − unified credit = estate tax |
- Valuation date: date of death, or the alternate valuation date — 6 months later (or the date of earlier disposition) — elected only if it reduces both the gross estate and the estate tax.
- Form 706 is due 9 months after death, with a 6-month extension available.
- Portability: a surviving spouse can use the deceased spouse's unused exclusion (DSUE) amount — but only if the executor makes the election on a timely filed Form 706, even when no tax is due.
- The generation-skipping transfer tax applies at the top rate to transfers to grandchildren or others two or more generations below, with its own exemption equal to the basic exclusion.
- Heirs receive a stepped-up basis equal to FMV at death.
Income taxation of trusts and estates
Types of trusts
| Type | Key feature | Exemption |
|---|---|---|
| Grantor trust (including revocable trusts) | The grantor retains powers or interests — the grantor reports all income; the trust is disregarded for income tax | — |
| Simple trust | Must distribute all income currently; no charitable contributions; no principal distributions that year | $300 |
| Complex trust | May accumulate income, distribute principal, or make charitable contributions | $100 |
| Estate | From death until administration is complete | $600 |
Distributable net income
Distributable net income (DNI) is the key concept. It:
- Caps the distribution deduction the trust or estate may take.
- Caps the amount taxable to beneficiaries.
- Determines the character of what beneficiaries receive (for example, tax-exempt interest keeps its character).
DNI generally equals taxable income before the distribution deduction and exemption, plus net tax-exempt interest, minus capital gains allocated to principal. The result is a conduit: income is taxed once — to the entity if retained, to beneficiaries if distributed.
Compliance
- Form 1041 is due April 15 for calendar-year trusts (trusts must use a calendar year; estates may choose a fiscal year), with a 5½-month extension. Beneficiaries receive Schedule K-1.
- Trust and estate tax brackets are highly compressed — the 37% rate applies at very low income (about $16,000) — which encourages distributions.
- The 65-day rule lets a complex trust or estate treat distributions made in the first 65 days of the next year as made in the prior year.
- Income in respect of a decedent (unpaid wages, traditional retirement accounts) is taxable to the recipient, with a deduction for any estate tax attributable to it.
- The net investment income tax (NIIT) applies to undistributed investment income above the (low) top bracket threshold.
How it is tested
- Compute taxable gifts using exclusions, gift splitting, and deductions.
- Identify items included in the gross estate and allowable deductions.
- Apply alternate valuation and portability rules.
- Classify a trust as simple or complex, and apply the role of DNI.
EXAM TIP: Pay tuition or medical bills directly to the provider and it's unlimited and excluded. Give the money to the student or patient first and it's an ordinary gift subject to the $19,000 annual exclusion.