The essential guide to estate planning and income taxes

Avoid income tax surprises with these considerations and planning points

Sep 01, 2023

Key takeaways

Careful planning can help you avoid unintended income tax consequences of estate planning decisions.

Tax laws governing pass-through income and S corporation shares require consideration.

Recent changes involving retirement plan accounts within an estate plan may require your attention.

Private client services Income taxes

You have mapped out your estate plan and feel confident in its estate tax efficiency. However, it is important to consider the income tax ramifications of each decision throughout the planning process to avoid unintended consequences. After all, an individual’s death, and the gifting they do during their life, affects many taxpayers, including the decedent; their surviving spouse, estate, and beneficiaries; and, potentially, their trusts.

RSM answers 10 important income tax questions and shares correlated planning ideas to consider when creating an estate plan:

Pass-through business income is typically categorized as active, passive, or portfolio. Ideally, taxpayers want income to be classified as active because it is generally treated more favorably under the tax code compared to passive income. If you are actively participating in your business, your business income may qualify for a lower tax rate or for the deduction of losses. It may be important to preserve this treatment after lifetime transfers or at death.

Determining whether certain business income is active or passive in relation to a trust or estate is not as straightforward as it is for individuals. Your participation prior to transferring the business interest is no longer relevant. There is no authoritative IRS guidance for how activities of a trust or estate are tested for participation purposes. Instead, participation rules and guidance for an estate or trust rely heavily on two prominent court cases, the Mattie K. Carter Trust and Frank Aragona Trust cases.

Based on case law, the participation of a trust or estate is determined by whether key individuals acting as a fiduciary (or agents of the fiduciary) are participating in the activity. The IRS has indicated it is going to propose regulations around this area. If and when those are issued, they could provide different guidance on how activities are tested for income tax purposes.

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Planning point: Consider the participation rules when choosing a trustee or executor. Your business income could be taxed at a higher rate, and losses may not be deductible, depending on whether the fiduciary participates in the income-producing activity. Use caution when relying on case law in your planning, because the IRS has not indicated that it agrees with the outcome of the cases.


Ensuring that your estate plan considers income tax consequences can be crucial to its success. Many of the strategies described above require technical analysis and familiarity with tax laws. Ensure your plan is up to date on the most recent changes in income tax law. If you have questions about how these or other topics affect your estate plan, consult with your RSM tax professional, who can help ensure your plan is up to date for the most recent changes in income tax law.

RSM contributors