Tax Implications in High-Value Probate & Trust Litigation

Executive summary

• Federal estate taxes ultimately affect a small portion of the population, but they are an important consideration for high-net-worth individuals in their estate planning.
• Possible tax implications in high-value estate and trust litigation can include federal estate taxes, state inheritance taxes, gift taxes, generation-skipping transfer taxes, and more.
• There are several practices that you may be able to take to reduce your tax obligations in probate and trust litigation.
• Before moving forward in any step of probate litigation, you should consult an experienced tax advisor or attorney to understand the complexities and your obligations as an interested party in an estate.

Tax implications in high-value probate

If you are an interested party in a high-value estate, then it’s important that you understand the tax implications involved with the estate and its assets. Trust litigation in legal and tax issues can be a key consideration in high-value estates.

Estates of high net-worth individuals are often subject to higher taxes because of the increased number of assets in the estate and the overall higher value of these assets. The reality is that federal estate taxes affect a very small part of the population, but if you are an ultra-high-net-worth individual or an interested party in one’s estate, they are an important consideration. 

Some tax implications facing an estate can include federal estate taxes, state estate and inheritance taxes, generation-skipping transfer taxes, and income taxes. Litigation often arises when there are disagreements about the valuation of specific assets, questions about the value of taxable assets, or concerns about the taxation of litigation settlements. 

Understanding tax litigation for probate is an important step for protecting the interests of an estate and ensuring that an estate is resolved in line with state and federal requirements. It’s also crucial for understanding potential tax obligations in trust litigation settlements. In any case, it’s always a good idea to consult a team that consists of experienced trust litigation attorneys and tax professionals or advisors to fully understand how tax implications are involved. 

Key tax considerations in high-value estate litigation 

Taxes are a common consideration in high-value estate litigation. Interested parties often must consider a few different types of taxes, ranging from federal to state taxes, when transferring their assets to beneficiaries. 

The most common considerations include: 

• Federal estate taxes 
• State estate taxes
• State inheritance taxes
• Income taxes
• Gift taxes
• Capital gains taxes
• International taxes
• Generation-skipping transfer taxes (GST)

State and federal income taxes are also important for heirs to consider. Heirs may be subject to paying taxes on their received inheritance, depending on the method in which they receive their inheritance and how large of a distribution they receive. 

These tax considerations also factor into litigation settlements. In some situations, the federal government may tax litigation settlements as income. However, every case is unique, so tax liabilities during litigation may vary depending on the facts of the case and the outcome reached.

Whether in estate administration or trust litigation, taxes are an important consideration for personal representatives and heirs alike. Ultimately, consulting tax experts is the best way for litigants to understand potential liabilities and obligations. 

Federal estate tax and exemptions

Federal estate taxes exist for the government to collect revenue on monetary transactions surrounding estates. The government imposes this tax specifically on estates of high-net-worth and ultra-high-net-worth individuals. 

The federal estate tax exemption allows anyone looking to transfer assets to heirs to pass over a designated amount before they are required to pay taxes on it. 

The 2025 lifetime exemption is $13.99 million, which is an increase from $13.61 million in 2024. However, in 2026, the federal estate tax exemption is expected to reset back down to $7,000,000, around 2017 levels, unless Congress acts to prevent this. This exemption helps high-networth individuals or families pass down gifts tax-free.

This exemption applies to a combination of multiple scenarios, including gift taxes,  estate taxes, and generation-skipping transfer taxes. Generation-skipping transfer (GST) taxes are another consideration for estates with trusts. The government has put GST taxes in place to prevent individuals from avoiding paying taxes by skipping children and leaving an inheritance for grandchildren through dynasty trusts instead.

State-specific tax implications in estate litigation 

Although federal estate taxes are the most significant consideration for many people when receiving an inheritance, state-specific taxes are an important consideration in high-value estate litigation, as high-net-worth individuals often have assets located across multiple states.

Currently, there are only 12 states and the District of Columbia that impose an estate tax. Meanwhile, only six states impose an inheritance tax (Iowa, Kentucky, Maryland, New Jersey, Pennsylvania, and Nebraska). Maryland is the only state with both. 

Neither California nor Texas impose an estate or inheritance tax, so you will only have to consider the federal estate tax in your estate planning. However, if you have assets located in multiple states, these assets may be subject to their own estate taxes. 

State income taxes may also apply to the beneficiaries in line to receive a share of assets depending on the asset they receive. Typically, an inheritance isn’t considered taxable income, but you may have to pay taxes on earnings through inherited retirement or investment accounts or on proceeds from later sold real estate.

Capital gains and step-up basis

Capital gains are the amount that an asset increases in value from its initial baseline—this baseline is the amount that an asset or investment was valued at the time of purchase. Capital gains taxes on assets at the time of death are a common consideration for estates of high-net-worth individuals who have valuable investments, real estate, or other tangible property that changes in value over time. 

Capital gains taxes are the taxes you pay on any income generated from an asset from the time you acquired it until the time it’s sold. For example, if a person has an investment valued at $45,000 and the investment increases in value to $62,000 over time, the capital gain of $17,000 will be taxed. 

Current laws surrounding capital gains taxes at the time of death mean that the basis of an asset is stepped up to the market value of the asset at the time of death. The step-up rule means that if a beneficiary inherits an asset and immediately sells it, they will not be responsible for any capital gains taxes. 

Typically, the party that sells the asset will be liable for the taxes on the income generated—if the owner sells the shares prior to their death, they will be liable for taxes on asset gains, whereas if a beneficiary inherits the asset, and retains ownership, they will be liable for any gains made during their ownership relative to the step up basis.

Tax implications of trusts in estate litigation 

Funds tied into trusts offer their own unique tax implications and are subject to different taxation rules. In fact, many people use trusts as a tool to minimize their tax obligations. However, trusts may have some unique considerations compared to taxes involved in probate and estate administration. 

Trusts can take two key forms:

• Revocable – A revocable trust is a type of trust that can be changed at any point prior to their death. Any income generated by a revocable trust is typically taxed to the creator during their lifetime and then to the beneficiaries after the creator dies and inheritances are distributed.
• Irrevocable – An irrevocable trust is a type of trust where the creator cannot make any changes once it is created unless all beneficiaries and interested parties agree. Income from irrevocable trusts is typically taxed to the beneficiary as income after inheritance distributions are made. 

Any income generated by a trust or the investment accounts within it is subject to taxation. Each beneficiary may be responsible for paying income or capital gains taxes on the assets that they receive from their family trust unless they sell their ownership of assets as soon as they receive them. 

There are many other types of trusts that can be used to minimize tax obligations for various situations, including grantor trusts, charitable trusts, cross-border trusts, qualified personal residence trusts, and more. Each type offers its own benefits, so you should consult an estate planning attorney and tax advisor to better understand your options.

Gift taxes and lifetime exemptions in estate litigation

Gift-giving is a tool that many high-net-worth individuals use to reduce the size of their estate over the course of their lifetime. The government offers a tax exemption for gifts made to others under a certain amount. 

The lifetime gift tax exemption is the money or assets that the government allows you to give away to others over the course of your lifetime before you are required to pay the federal gift tax. The lifetime gift tax exemption is grouped into the federal exemptions—again, this would be $13.99 million for 2025. 

International tax issues in cross-border estates

A common theme amongst the estates of high-net-worth individuals is possessing assets in other countries overseas. Common examples of assets include yachts, private jets, mansions, real estate, business interests, overseas accounts, and more. It’s important to understand the tax requirements in each jurisdiction where assets were located, not just in the primary jurisdiction where the estate administration is taking place. 

The international jurisdiction may tax any property transferred or sold within their borders. In some cases, assets may be subject to double taxation by the international state and the home state if not planned for properly. 

However, tax laws and implications may vary widely from country to country. Given the risks of additional taxation and the potential for laws like forced heirship in other countries to catch estate representatives by surprise, it’s important that heads of an estate are proactive and carefully consider their estate plans.

Our team at RMO has an extensive network of attorneys, tax professionals, and professional appraisers worldwide. With advanced experience in estates of high-net-worth individuals, we’ll help you get connected with the resources necessary to protect your interests in an estate. 

Strategies to minimize tax liability in high-value estate litigation

There are steps that high-net-worth individuals can take in their estate planning to minimize their family’s tax liability during estate administration and litigation. In fact, many estates make it a significant goal to reduce their tax liability over the course of their estate planning.

Tax-efficient strategies for estate planning include: 

• Using gifting strategies to family members and charitable contributions to lower the overall taxable estate value.
• Establishing joint ownership of assets with beneficiaries, or transfer on death accounts, so that these assets do not require estate or trust administration to be transferred.
• Creating a family limited partnership (FLP) to pool resources of family members as an investment entity, which can then be gifted to other family members.
• Establishing a limited liability corporation (LLC) to transfer ownership from the estate to the organization.
• Restructuring a trust to maximize tax benefits. 
• Setting up a trust in a low-income tax state to reduce tax obligations.

In litigation, you can minimize the amount of tax liability by protecting your assets and using the above avenues to transfer assets to beneficiaries. Reducing the size of an estate prior to trust or estate administration can help you reduce your tax risks when entering litigation or other disputes.

In any case, it’s essential that you consult experienced tax professionals, estate planning attorneys, and probate and estate administration attorneys as soon as possible to most effectively minimize tax liabilities and minimize the risks of litigation.

Role of tax advisors in high-value estate litigation 

Ultimately, there are many steps you can take to potentially minimize your estate’s tax liability, but you should always consult a skilled professional before taking these steps on your own. Tax advisors are essential in the process of high-value estate litigation. Tax professionals can provide critical guidance on tax laws and help to minimize liabilities. 

Tax requirements can quickly become muddy and confusing, so it’s crucial that you have the guidance of a skilled tax advisor in your jurisdiction. If you have assets in other locations, whether in another state or country, you should consult with a tax advisor with specific expertise in that jurisdiction’s tax laws and requirements.

Ideally, for the greatest potential of protecting the interests of your estate, your team should contain multidisciplinary professionals, including tax professionals, professional appraisers, experienced legal professionals, and financial experts. Be sure to choose experienced tax advisors who understand estate litigation and the potential impacts of litigation on your tax obligations. 

Recent legal and tax developments impacting estate litigation

Ongoing law changes and new precedents set by court decisions can have important implications for probate and trust litigation. The following are some important tax developments to consider that impact estate litigation.

Estate tax exemptions

Federal estate tax exemptions and requirements change frequently according to IRS guidelines with the passing of the 2017 Tax Cuts and Jobs Act. The act raised the tax lifetime estate tax exemption and set it to change annually. Between 2024 and 2025, the exemption rose from $13.61 to $13.99 million.

For example, in 2026, this requirement is expected to revert back to pre-2017 levels, adjusted for inflation, which is projected to be around $7 million. However, it’s possible that legislation will be passed before then to extend or adjust the exemption increase.

These tax exemption changes have important implications for estate management and may vastly alter how someone decides to structure their estate plans. As a result, it’s important to stay informed about ongoing potential changes to understand how they may affect your trust or estate.

Connelly v. United States (2024)

The Supreme Court case of Connelly v. United States involved two brothers, Michael and Thomas Connelly, who shared ownership of a roofing company. Michael owned 75% of the shares of the company, and Thomas owned the remainder. The two created a redemption agreement that stated that upon one brother’s death, the survivor would have the option to purchase their shares. 

If the survivor opted not to purchase the shares, then the company would be required to redeem them. Both brothers took out life insurance policies of $3.5 million in the name of the company. When Michael died, Thomas opted not to purchase his brother’s shares, so the company was forced to redeem them at the value of $3 million and Thomas was considered the sole shareholder in the company.

As the executor of his brother’s estate, Thomas valued Michael’s shares in their business as $3 million and excluded the life insurance proceeds from the business valuation. During an audit, the IRS counted the life insurance proceeds in the company’s valuation and argued that the valuation of Michael’s shares should instead be closer to $5 million, which significantly increased the tax obligations of the estate by almost $900,000.

Thomas argued that Michael’s life insurance costs were a liability to the company, and should offset the life insurance proceeds while reducing the size of his shares. However, the Supreme court ruled in this case that Michael’s shares in the company were higher than the initially reported $3 million, and that the IRS was correct to include the life insurance proceeds in Michael’s estate and tax it accordingly.

The decisions from Connelly v. United States emphasize the importance of consulting a tax advisor and estate planning attorney when discussing such important matters. In this case, a more detailed estate plan, such as using an irrevocable trust would have been a more beneficial approach for transferring Michael’s life insurance proceeds and share in the business and avoiding such high taxes. 

Interpretations of Sections 2036 and 2038 of the Internal Revenue Code

Sections 2036 and 2038 of the Internal Revenue Code state that certain property must be included in an estate and is subject to tax if transferred to a beneficiary by a decedent during their lifetime, even if the decedent did not have title to that property. Multiple recent cases have addressed these sections in the context of split-dollar life insurance arrangement—including Estate of Levine, Estate of Morrissette, and Estate of Cahill. 

In each of these cases, the estate used a trust to pay life insurance premiums and transfer benefits to their beneficiaries. A key element of each case is that the IRS argued on Form 706, the executor undervalued the trust’s split-dollar rights to the decedent’s life insurance policy. The implications in each of these cases was whether an estate can use split-dollar contracts to transfer assets and minimize the size of the taxable estate.

In Estate of Morrissette and Estate of Cahill, the court found that the decedent was the creator of a revocable trust and maintained power to terminate the arrangements, so this constituted a transfer of property during their lifetime. As a result, the court found that the estate was subject to the higher valuation and the relevant taxes.

In Estate of Levine, however, the court found in favor of the estate and upheld the lower valuation because an irrevocable insurance trust owned the policies and had control rather than the decedent, The tax structure in Levine serves as a model for estates that involve split dollar contracts and tax implications for the transfer of estate property. 

Practical steps for heirs and trustees navigating tax implications 

Heirs, trustees, and other interested parties in an estate must consider steps they can take to navigate taxes and minimize potential penalties against an estate or trust. Some valuable steps to take include:

1. Careful record keeping – Maintaining a detailed record of assets and investments will ensure that you can defend against potential IRS challenges or disputes to any estate transactions during litigation. 
2. Accurate asset valuation – Tax amounts are based on the value of a given asset or investment, so accurate valuation is essential for understanding your tax obligations.
3. Understanding trustee responsibilities – If you are a trustee or executor of an estate, it’s crucial that you understand your responsibilities to pay taxes in order to avoid excess taxes or fees being levied against the estate.
4. Seeking legal and tax guidance – Seeking the guidance of skilled tax and legal professionals will allow you to understand your obligations and how to navigate them. 

If you are a trustee or executor seeking to protect the interests of a trust or estate, you should seek the support of a skilled attorney who can help you understand your duties and obligations without running into issues. For more advanced tax guidance, you should consult an experienced tax professional to navigate and understand the complexities of estate taxation.

Navigate estate litigation with RMO Lawyers 

Understanding the potential tax litigation for probate or trust administration is crucial for navigating the process carefully and ensuring you fulfill all legal requirements. By understanding your tax obligations, you can put yourself in the best position to resolve disputes and responsibly administer your estate. Still, tax obligations and trust litigation in legal and tax issues can be incredibly nuanced and complex. In any tax-related situation, we recommend consulting an experienced tax consultant or estate tax attorney. 

However, if you are facing trust or probate litigation as an interested party in an estate, we can help. We’ll use our network to connect you with experienced tax professionals who can provide further guidance around estate tax obligations while we help you navigate the litigation process. We take a compassionate approach to all cases to advocate for the best interests of an estate and its beneficiaries.

Schedule a consultation with our attorneys at RMO to discuss your options in litigation.