Surviving Tax Season

Taxes That Can Impact Your Estate Plan

Estate planning involves deciding how to plan for the management of your money, property, and well-being before your death and how to distribute your money and property after your death. A comprehensive estate plan should consider the impact that taxes can have on your estate and ensure that your estate is distributed in a tax-efficient manner. There are several different types of taxes that can impact you and your estate plan, including individual income tax, estate income tax, trust income tax, gift tax, estate tax, generation-skipping transfer tax, and state inheritance tax.

Federal Individual Income Tax

The federal individual income tax is a graduated tax (the tax rate adjusts based on the amount being taxed) that individuals pay on their personal income. If you currently own income-producing assets such as rental property, stocks, or a business, the income they generate is subject to income tax, and the tax liability can be significant. Alternatively, charitable entities are typically subject to lower tax rates and no capital gains. We can discuss whether transferring accounts and property to a trust or charitable organization would benefit you, where the value of income-producing accounts and property and their future income can be removed from your taxable estate. On the other hand, owning appreciating accounts and property until death will allow them to receive a basis adjustment to their fair market value as of the date of your death, which can eliminate or significantly reduce capital gains taxes if your beneficiaries sell property or liquidate accounts. When considering these planning strategies, it is important to weigh the income and estate tax consequences.

Federal Trust Income Tax

Trusts are legal entities that can hold and manage accounts on behalf of one or more people (beneficiaries). There are several kinds of trusts and their tax treatment varies. As a separate entity, some trusts are subject to their own federal income tax. Trusts reach the highest marginal income tax rate much faster than individuals and most trusts are subject to income tax on any income their accounts and property generate and retain. Also, depending on the trust structure, tax liabilities can impact the value of the trust. Money paid by the trust for income tax liabilities, means there is less money available to the beneficiaries. If the trust distributes money or property to the beneficiaries, the income tax associated with the money or property is then paid by the beneficiaries at their individual income tax rates.

Federal Gift Tax

The federal gift tax is imposed on gifts made during an individual’s lifetime. The tax is designed to prevent people from giving away their money and property during their lifetimes to avoid estate taxes at death. The gift tax may impact your estate plan if you wish to make large gifts to family members or other beneficiaries. To minimize the impact of the gift tax, you may want to consider gifting accounts and property in a tax-efficient manner, such as taking advantage of the annual gift tax exclusion.[1] We are happy to discuss with you the legal nuances of your contemplated gifting strategy.

Federal and State Estate Taxes

Estate tax exists at the federal level and in some states, and may be imposed on the value of everything you own or control when you pass away. Estate taxes are based on the total value of all money and property you own at the time of your death, and the tax can be significant. To minimize the impact of estate tax on your estate plan, you may want to consider transferring accounts and property out of your estate by making gifts while you are alive (but beware of the potential gift and generation-skipping transfer tax consequences), by transferring accounts and property to individual beneficiaries, certain types of trusts, or giving money to a charitable organization. You may also be able to take advantage of the large current estate and gift tax exemption, which allows a certain amount of accounts and property to pass tax-free to your beneficiaries. It is important to note that your beneficiaries will receive your tax basis in property transferred to them during your life, so highly appreciated property that is later sold may have significant capital gains tax consequences. Before undertaking any gifting strategy, we can discuss the appropriate structure for your objectives as well as the various income and transfer tax consequences.

State Inheritance Tax

State inheritance tax is imposed on a person’s money and property after they pass away, and is based on who inherits the money and property, as opposed to estate tax, which is based upon the overall value of the decedent’s accounts and property. Also, while an estate tax is usually paid out of what the decedent owned, an inheritance tax is paid by the person who inherits the money and property. Tax rates and exemptions vary by state, and some states do not have an inheritance tax. We are happy to discuss with you your state’s law and what tax obligations your beneficiaries may have at your death.

Bottom Line

There are many different types of taxes that can impact your estate plan and influence your planning decisions. If you are concerned about the impact that taxes may have on your current estate plan, we are happy to meet with you to discuss this and any other questions you may have. With careful planning, we can structure your estate plan in a tax-efficient manner to minimize overall tax liability.

Balancing Act: What Matters Most to You?

When people begin getting their affairs in order through the creation of an estate plan, they often face a delicate balancing act between saving on income and estate taxes, protecting their hard-earned savings from their ultimate beneficiaries’ creditors, and providing maximum benefit to their loved ones. Finding the right balance requires careful consideration of the different legal and financial tools available to help you fulfill the vision of your estate plan.

Saving on Income and Estate Taxes

Income and estate taxes can be significant expenses for individuals and their beneficiaries, potentially reducing the amount of money and property that you can pass on to your loved ones. To save on estate taxes, you can consider several strategies, including gifting money and property to your loved ones or creating trusts for their benefit. Alternatively, utilizing tax-advantaged investment accounts can be beneficial for income tax savings.

Gifting money and property during your lifetime can help reduce the amount you own at your death and, in turn, reduce the amount that is subject to estate tax, if done properly. In 2023, the annual gift tax exclusion, which is the maximum amount you can give to someone during the year without any federal gift tax concerns, is $17,000 per recipient ($34,000 per recipient for married couples making joint gifts). Likewise, under current law, you could give away up to a total of $12.92 million during your lifetime before triggering any federal estate tax. By gifting accounts and property to beneficiaries during your lifetime, you can shift any income tax burden from those accounts or pieces of property, if any, to the recipients, who are typically in a lower tax bracket and therefore pay less tax on income generated by the accounts and property. It is important to note that if you give accounts or property to someone during your lifetime, and the accounts or property greatly appreciate in value from when you acquired them, the recipient could end up with a large capital gains bill when they decide to liquidate or sell. Also, if you choose to give accounts and property outright to your loved ones, you will no longer be able to control how the money is spent or the property is used. The money and property may also be subject to your loved ones’ creditors or divorcing spouses.

Creating trusts is another strategy for saving on taxes. Trusts are legal entities that hold and manage accounts and property on behalf of beneficiaries, and they can be structured in a variety of ways to minimize taxes. For example, an irrevocable trust, in which the trustmaker typically cannot change the trust, pays its own income tax on the income generated by the trust’s accounts and property because it is seen as a separate entity from the trustmaker. Although the trust is responsible for paying the income tax, the trust’s accounts and property can grow estate tax-free for the beneficiaries because the trustmaker no longer owns them. The creation of this type of trust may require the use of your annual gift tax exclusion or lifetime gift and estate tax exclusion. Also, because it is seen as a separate entity, certain types of irrevocable trusts can be used to offer you asset protection as it relates to the accounts and property that you have transferred to the trust. However, you will have to give up control over the trust going forward.

Another way you might save on income taxes is to leverage tax-advantaged investment accounts, such as individual retirement accounts (IRAs) and 401(k)s. These accounts allow individuals to defer taxes on their contributions and investment earnings until retirement, when they may be in a lower tax bracket. Other investment accounts such as Roth IRAs and Roth 401(k)s allow individuals to make after-tax contributions, with any subsequent earnings and withdrawals being tax-free.

Protecting Assets from Creditors

Another important consideration in estate planning is protecting your accounts and property from creditors. Creditors have a legal claim to accounts and property, and if accounts and property are not properly protected, creditors may be able to seize them to satisfy a debt or legal judgment against you or a beneficiary.

One way to protect accounts and property from creditors is to create a trust with certain terms. Trusts can be designed to provide a degree of insulation between accounts and property and potential creditors. For example, if your loved one has poor spending habits or creditors, a spendthrift trust could be included in a revocable or irrevocable trust to restrict the family member’s access to the trust’s accounts and property, making it more difficult for creditors to reach them.

However, a trust with a spendthrift provision alone does not offer a high level of protection from creditors. A discretionary trust can give the trustee discretion over when and how to distribute money and property to the beneficiary, allowing the trustee to avoid distributions that might be vulnerable to seizure by creditors. Another important factor contributing to a trust’s level of creditor protection is the identity of the trustee. Ideally, the trustee is an independent party who is not related or subordinate to the beneficiary. A properly drafted and structured discretionary trust restricts the amount of money and property, including income, that the beneficiary has access to. If the income generated from the trust’s accounts and property is kept by the trust and not distributed to the beneficiary, that income could be taxed at the trust’s income tax rate, unless the trust is designed so the trustmaker is responsible for the tax obligation. Both provisions can be included in a revocable or irrevocable trust.

It is also important to note that trusts and individuals are taxed differently when it comes to income. Individuals are subject to a graduated income tax system, where the tax rate increases as income rises. In 2023, the top marginal tax rate for individuals is 37 percent, for income over $523,600 for individuals and over $628,300 for married couples filing jointly. Trusts, on the other hand, are subject to a compressed tax bracket system, where the top marginal tax rate of 37 percent applies to any income over $13,451. This means that trusts may be subject to a higher tax rate on the same amount of income than an individual in a similar tax bracket.

If you are looking to protect your accounts and property from your own creditors, you would need to consider certain types of irrevocable trusts. As previously mentioned, an irrevocable trust means that you lose control over the accounts and property that are placed in the trust, and the amount paid in income tax could be higher if the income from the trust is not distributed to a beneficiary or the trust is not designed for the trustmaker to be responsible for the income tax obligation.

Giving Beneficiaries Maximum Access

Although saving on taxes and protecting accounts and property from creditors is an important estate planning objective, you may also be concerned whether your beneficiaries have complete access to their inheritance. This can be especially important if you want to support your loved ones’ needs and do not want to restrict their access because the future is unknown.

One way to give maximum access to beneficiaries is to structure the estate plan in a way that allows for unhindered or outright distributions to the beneficiaries. This can be accomplished through various means, such as creating a revocable living trust with lenient distribution instructions, allowing the beneficiaries to receive the money and property outright at your death, or giving them the money and property outright during your lifetime. By giving beneficiaries control over the accounts and property, they can use them as they see fit. However, giving beneficiaries maximum access to their inheritance can also come with risks. For example, beneficiaries may be tempted to spend the money or liquidate the property unwisely, or they may be vulnerable to fraud or manipulation. In addition, giving your beneficiaries maximum control over money and property may increase their exposure to creditors and legal claims, such as divorce.


Balancing competing interests requires careful consideration—what are your goals and priorities? How can you best accomplish them? What are you willing to give up to carry out your plan? Working together, we can help you navigate these complex issues and create an estate plan that achieves your objectives. Give us a call to start or review your estate plan.

[1] It is important to note that Connecticut has their own gift tax.