Tax Considerations in Estate Planning
Estate planning involves more than deciding who inherits wealth. It also addresses the tax consequences of wealth transfers during life and after death. Although today’s federal estate tax exemption is historically high and shields most Americans from federal estate tax, tax planning is still needed.
A “taxable estate” includes all property owned at death. This generally encompasses real property, financial accounts, personal belongings and business interests. Assets held in certain types of trusts are not counted because the trust owns them.
Do Spouses Pay Taxes When the First Spouse Dies?
Married couples receive meaningful tax protections. The unlimited marital deduction allows spouses to inherit from each other tax-free. In addition, the federal estate tax exemption is portable, meaning any unused portion of the first spouse’s exemption can be transferred to the surviving spouse if proper planning is done. There is usually no federal estate tax at the first death. However, the second spouse to die often generates state estate taxes and possible inheritance taxes.
Will You Need to Plan for Inheritance Taxes?
Only five states: Kentucky, Maryland, Nebraska, New Jersey and Pennsylvania, still impose inheritance taxes. There, the tax owed depends on the heir’s relationship to the decedent; more distant relatives often face higher rates and lower exemptions.
Why Should Estate Planning Address Income Taxes?
Required Minimum Distributions (RMDs) from retirement accounts are taxable income to the owner. Large RMDs can reduce an estate’s size and push a taxpayer into a higher income bracket. Strategic Roth conversions or thoughtful trust planning may mitigate these effects.
Are Different Types of Inheritances Taxed Differently?
How assets are allocated among heirs can create tax disparities. For example, if one child receives the family home, another receives undeveloped land and a third receives the rest of the estate, tax obligations may fall unevenly. Some trusts direct the trustee to pay taxes from the “residuary estate,” which can unintentionally burden one heir more than others. Equalizing the tax impact requires clear drafting and thoughtful coordination of asset types.
Capital gains tax is another core consideration. At death, most assets receive a step-up (or step-down) in basis to fair market value. If a beneficiary sells the day after death, they may owe little or no capital gains tax. In contrast, if property is gifted during life, the recipient receives a carryover basis, potentially exposing them to significant capital gains tax on a later sale. Deciding whether to transfer property during life or at death requires analyzing appreciation, anticipated selling timelines and the overall tax impact.
Are There Still Deductions for Charitable Donations?
For those who are philanthropically minded, strategic gifting to a qualifying charity can be structured to save capital gains taxes, increase income and provide beneficiaries with income for life. Depending upon how they are structured, charitable gifts may also provide estate tax deductions.
Tax Planning and Tax Planning Should Take Place in Tandem
Estate planning is not a one-time task. Many older estate plans, especially those created before the most recent sweeping tax law changes, may now produce unintended or inefficient tax results. Regular adjustments ensure that your plan minimizes estate, gift, income and capital gains taxes while protecting your heirs and honoring your intentions.
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