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Taxes navigating through a maze

Keep in mind three critical tax issues in estate planning

by Robert Bailey | Contributor
April 27, 2022

The federal estate tax often receives the lion's share of the focus when one is evaluating their potential tax obligations during the estate planning process. An estate's federal estate tax liability is based on the total value of a decedent's estate before any distributions are made to its beneficiaries. In many instances, estates will not owe any federal estate tax that, as of 2022, is only applicable if your estate is valued at over $12.06 million.

Individuals may also be aware of state estate taxes, which is a more common concern as their dollar thresholds are lower. However, state estate taxes are only required in 12 states and the District of Columbia. Depending on the state controlling your estate, these taxes begin to be imposed once assets in the estate rise above $1 million, although the threshold is higher for many of these states.

In another six states, they have what is known as an inheritance tax, which is like an estate tax except each individual beneficiary, subject to certain exceptions, is responsible for paying taxes for the portion of the estate they received as opposed to the tax being paid by the estate before distribution. Only one state, Maryland, has both an estate and inheritance tax.

However, once you get beyond these more well-known estate taxes, there are other important tax issues that you need to be aware of when planning your estate. Even if you carefully set up your estate to avoid the payment of estate or inheritance taxes, you must also take into consideration these three common tax issues: income taxes; appreciated assets; and the varying tax obligations of beneficiaries.

Income taxes

Regardless of the value or location of the decedent's property, many estates will be required to pay income taxes that may turn out to be an unexpected burden. This burden can be further exacerbated due to the high likelihood that any estate income earned will be taxed at a higher than anticipated rate since estate and trust rates are compressed when compared to the rates applied to an individual's personal income.

Let's take a look at the numbers to fully understand the impact of an estate's compressed income tax rate. For personal income taxes in 2022, the top tax bracket of 37% applies to taxable income of $523,601 ($628,301 if married and filing jointly) or more. Contrast that with the compressed rate of estates and trusts that reaches the 37% tax bracket when there is taxable income of only $13,451 or higher. For this reason, it is typically most advantageous for an estate to close the estate as quickly as possible to avoid accumulating excessive income subject to these higher rates. This can be accomplished in many ways by thoughtful estate planning.

So, you might ask, how does an estate receive income? Estates can receive income in a variety of ways. For instance, during the time an estate is in existence, it can generate income in the form of interest income or dividends from assets (e.g., savings accounts, CDs, stocks, bonds and mutual funds) that are part of the estate.

Other common examples of estate income include the receipt of rent from a decedent's real estate or salary that was not paid to the decedent until after their death. Income taxes are even required if the decedent's property is held in trust. This includes both irrevocable and revocable trusts. That is because if a decedent dies with a revocable trust, it would no longer be revocable and, thus, the income it generates subsequent to the decedent's death would be subject to income taxes. In addition, a separate tax return would also have to be filed on behalf of the trust. Remember, with these examples and more, this estate income is subject to income tax regardless of whether an estate is exempt from federal and state estate taxes.

Similar to personal income taxes, the filing can be as simple or complicated as the estate itself. The IRS requires the executor to file an income tax return on behalf of the estate if there is a gross income in the estate for that tax year of $600 or greater. Income taxes for both estates and trusts (a common asset used in estate planning) are filed using Form 1041 - U.S. Income Tax Return for Estates and Trusts. This form, which is commonly referred to as a “fiduciary” return, is very similar to Form 1040, which is the form individuals use to file their personal income tax returns each year.

Just like your personal income tax return, the estate income tax return will typically consist of income, gains, losses, credits and deductions for the estate during that year. Some of the common deductions the executor can take on behalf of the estate are as follows: income required to be paid to the beneficiaries; executor's fees; expert fees (i.e., attorneys, accountants and tax preparers); as well as other administration expenses incurred while collecting assets, paying debts and distributing the estate's property.

In addition to these deductions and expediting the estate process, there are other proactive actions that can be taken during the estate planning process to avoid excessive income taxes. The most obvious way is to strategically structure assets in a manner that avoids producing estate income. So, what are some ways you can do this? If you have a rental property, you can hold it in joint tenancy with an individual you would have otherwise bequeathed the property to in your estate.

This would ensure that the income-producing property passes immediately to the surviving owner upon your death. The same can be done with various bank accounts by setting them up with a payable-on-death designation. By doing this, the transfer of the account's ownership occurs immediately and, thus, will not sit in the estate where it would likely produce income.

Another income tax that is often overlooked is a decedent's final income tax return. In addition to an estate income tax return, a final income tax return for the decedent will also need to be filed for the year the decedent passed away if they received any income before their death. This final return is prepared similar to returns the decedent would have filed when they were alive and should include their earned income as well as any credits or deductions they are entitled.

Appreciated assets

When an asset is sold that has an appreciated value, its long-term capital gain is taxed at a rate of either 0%, 15% or 20%, with the top rate in 2022 applying when income exceeds $517,200 for a joint return and $459,750 for a single return. The capital gain subject to this tax is the difference between the realized amount (i.e., sales price) and the basis of the asset. The default basis is typically the price that was originally paid for an asset.

So, if an individual buys a house in 2010 for $300,000 and then sells it in 2022 for $400,000, the individual selling the house would, subject to certain exceptions and exemptions, be required to pay capital gains taxes on the $100,000 appreciation of the asset. Generally speaking, this is the case whether the asset is sold by the individual who made the purchase in 2010 or if it was gifted to another individual prior to the sale. That is because, under the federal tax code, assets transferred as a gift retain the original basis of the transferor.

an older couple that appears to be stressed while looking at tax problems on their laptop

Here is yet another important tax issue where proper estate planning can save the estate and its beneficiaries a significant amount of money. With appreciated assets, there is a recalculation that occurs when the asset becomes part of a decedent's estate. When this occurs, the appreciated asset is recalculated to its fair market value on the date the decedent died.

This recalculation, referred to as a step-up in basis, can have a significant impact on the amount of taxes an estate or beneficiary of an appreciated asset has to pay. Let's look at the practical savings this can provide by continuing the example above with the $300,000 house purchased in 2010. If you were to simply gift this house before you died, and the individual sold the house in 2022 for $400,000, they would be subject to capital gains taxes on the $100,000 the asset appreciated over the last 12 years.

If, however, the original owner died owning the property in 2022 and the estate distributed the house to a beneficiary, this same sale in 2022 would likely be subject to minimal capital gains tax. The beneficiary would only have to pay capital gains taxes on any appreciation from the date the decedent died until the date the property was sold later that year. It effectively wiped out 12 years of appreciation and reset the value to a significantly more recent time, resulting in little to no capital gains taxes.

As with almost everything in the federal tax code, there are exceptions. A major exception to capital gains for an appreciated asset is with an inherited individual retirement account (IRA). Inherited IRAs are not subject to capital gains taxes. Rather, an inherited IRA is taxed as ordinary income during whatever year withdrawals are taken. Inherited IRAs will be discussed at more length below as the tax obligation can vary significantly depending on the beneficiary of the account.

Varying tax obligations for beneficiaries

  • Asset type. Tax obligations will vary based on the type of asset a beneficiary inherits. For instance, life insurance proceeds are not subject to income tax. Bank accounts and certificates of deposit with a beneficiary designation are not subject to capital gains taxes, but interest is taxable income. Brokerage accounts and most other appreciated assets are subject to capital gains tax based on the basis at the decedent's date of death and the rate is determined by the beneficiary's taxable income.
  • State law. Other factors that impact a beneficiary's tax obligation is the state law controlling the administration of the estate. One example is with inheritance taxes that we previously mentioned are required if you live in one of the six states where this tax is applicable. Even if you are in one of these states, there are often varying rates depending on the beneficiary's relationship to the estate. For instance, spouses are typically exempt from inheritance taxes while non-family members are usually taxed at the highest rate.

Beneficiary's relationship to decedent

Tax obligations can vary greatly even if beneficiaries are receiving the same type of asset controlled by the same state's law. Inherited IRAs are a great example of how a beneficiary's tax obligations may be dependent on their relationship to the decedent. Generally, inherited IRAs produce taxable income, but the tax obligation is typically delayed and prolonged. That is because for inherited IRAs income taxes are not due when inherited but when the beneficiary makes withdrawals from it. Of course, the tax code is complicated, so there are further rules and exceptions to these rules.

The Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE Act) added some major changes to inherited IRAs that have resulted in some significant tax implications. This is where you can see how a beneficiary's relationship to the decedent can impact their tax obligation. In the case of IRAs inherited after Jan. 1, 2020, a beneficiary must withdraw the entire balance of the IRA by Dec. 31 of the year coinciding with the 10th anniversary of the owner's death. These withdrawals are then subject to income taxes. An IRA that is large enough can result in a significant tax obligation to the beneficiary, even if the distributions were simply transferred into a beneficiary's own IRA.

However, there is an exception to the 10-year rule for the following individuals: a surviving spouse; a disabled or chronically ill person; a minor child; and a person not more than 10 years younger than the IRA. For these individuals, other than a surviving spouse, they are exempt from the 10-year rule but still obligated to take an annual required minimum distribution (RMD).

For a surviving spouse, they have even greater flexibility and are not required by default to take an RMD. They can either treat the IRA as their own, roll its funds into an existing IRA or treat themselves as the account beneficiary. The only requirements for a surviving spouse are the traditional rules and taxes associated with distributions taken from an IRA.


While estate and inheritance taxes are important, make sure your estate plan addresses all potential tax issues that may arise during the administration and distribution of your estate. Being aware of these common issues during the estate planning process can provide two great benefits. First, careful estate planning can ensure that your estate and beneficiaries incur the minimum amount of taxes possible. This includes not just estate and inheritance taxes but income and capital gains taxes as well. Second, planning to minimize the impact of these taxes in advance will make for a less complicated estate which will make the job of your executor significantly easier. Have further questions? You can seek out the advice of an experienced Legacy Plan Network Attorney to answer any specific questions as it pertains to the planning of your estate.

How do I create an estate plan?

There are numerous options and scenarios to consider when developing an estate plan that protects your legacy and achieves your objectives, and important decisions should be made with the advice of qualified lawyers and financial experts. Membership with Legacy Assurance Plan provides members with valuable resources and guidance to develop comprehensive estate plans that take life's contingencies into consideration and leave a positive impact for generations to come. Legacy Assurance Plan members also receive peace of mind that a team of trusted, experienced professionals will assist them in developing legal, financial and tax strategies that will meet their needs today and for years to come through periodic reviews.

This article is published by Legacy Assurance Plan and is intended for general informational purposes only. Some information may not apply to your situation. It does not, nor is it intended, to constitute legal advice. You should consult with an attorney regarding any specific questions about probate, living probate or other estate planning matters. Legacy Assurance Plan is an estate planning services company and is not a lawyer or law firm and is not engaged in the practice of law. For more information about this and other estate planning matters visit our website at

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