Tax Pitfalls to Avoid When Creating Your Indiana Estate Plan

Developing an estate plan involves more than deciding how your property will be distributed after death. A comprehensive plan must also account for taxation, administrative efficiency, and the long-term financial stability of your beneficiaries. Even a well-drafted plan can fall short if tax implications are misunderstood or ignored. Estate taxes, gift taxes, and income taxes can significantly diminish the value of what you intend to pass on if you fail to plan for these potential tax burdens, rely on outdated information, or attempt to navigate complex tax rules without professional guidance. To reduce the risk of costly errors, the Indianapolis lawyers at Frank & Kraft explain several common tax pitfalls to avoid when creating your Indiana estate plan.

Underestimating the Impact of Taxes

Gift and estate taxes are assessed based on the total value of gifts made during your lifetime and assets owned at death. While Indiana does not impose a state-level estate or inheritance tax, federal estate tax laws still apply and remain subject to change. People often make the mistake of assuming that their estate will not be large enough to trigger taxation, leading them to overlook planning opportunities. This assumption can result in costly mistakes.

As of 2026, the federal estate tax lifetime exemption stands at $15 million per individual while married couples can effectively shield up to $30 million through coordinated planning. Estates that exceed these thresholds may be subject to substantial taxation. While this exemption appears generous, it does not account for future asset growth or legislative changes. Real estate, investment portfolios, and business interests can appreciate significantly over time, potentially increasing the size of your estate beyond current expectations.

In addition, federal exemption levels have shifted repeatedly in the past and may change again. Relying solely on current thresholds without incorporating flexibility into your estate plan can expose your assets to unnecessary taxation in the future. Including adaptable tax-planning provisions within a revocable living trust or related documents allows your plan to respond to evolving laws. Tools such as marital trusts, credit shelter trusts, and structured lifetime transfers can help preserve wealth and reduce exposure to estate taxes, even if exemption levels decrease.

Lifetime Gifts

A frequently misunderstood area of tax planning involves the tax treatment of lifetime gifts. Gifting assets during your lifetime can be an effective way to reduce the size of your taxable estate while providing financial support to loved ones, but this strategy requires a clear understanding of applicable tax rules to avoid unintended consequences.

The Internal Revenue Service allows you to make annual gifts up to a certain amount per recipient without incurring gift tax or filing a gift tax return. For 2026, the annual exclusion amount is $19,000 per recipient. Married couples can combine their exclusions to gift up to $38,000 per recipient each year. Gifts that exceed this threshold are not automatically taxed, though they must be reported and will reduce your lifetime exemption, set at $15 million per individual in 2026. Large gifts made during your lifetime will gradually reduce this exemption, potentially increasing the tax burden on your estate in the future. Without careful planning, repeated gifting can undermine the overall tax efficiency of your estate plan.

Gifting Appreciated Assets

Another important tax consideration involves the transfer of appreciated assets. When you gift an asset during your lifetime, the recipient generally assumes your original cost basis and if the recipient later sells the asset, capital gains tax may apply to the full amount of appreciation. In contrast, assets transferred at death typically receive a step-up in basis, which adjusts the value to the fair market value at the time of death. This adjustment can significantly reduce or eliminate capital gains tax when the asset is sold.

Failing to account for this distinction can result in unintended tax consequences for your beneficiaries. In some cases, retaining appreciated assets until death may be more advantageous from a tax perspective than gifting them during your lifetime. Strategic gifting requires careful evaluation of timing, asset type, and overall estate planning objectives. Proper documentation and coordination with your broader plan are essential to ensure that gifting strategies enhance, rather than undermine, your tax position.

Payment of Estate Taxes

One of the most common and consequential tax mistakes involves failing to clearly assign responsibility for paying estate taxes. When taxes are owed, determining who bears that burden becomes a critical issue. Unfortunately, many estate plans include generic provisions stating that taxes should be paid from the “residuary estate,” which consists of the remaining assets after specific gifts have been distributed. While this approach may appear straightforward, it can produce unintended and inequitable results among beneficiaries.

For example, consider a situation where one individual inherits real estate, another receives ownership of a closely held business, and a third is left with liquid assets such as cash or investment accounts. If the estate plan directs that all taxes be paid from the residue, the beneficiary receiving liquid assets could be responsible for the entire tax obligation. Meanwhile, the other beneficiaries might receive high-value assets without contributing to the tax burden, even though those assets contributed to the total taxable value of the estate.

This type of imbalance can create significant tension among heirs and often leads to disputes. Litigation over tax allocation can delay estate administration, increase costs, and strain family relationships. These outcomes rarely reflect the intent of the person who created the plan. A more precise strategy involves including clear instructions regarding how taxes should be apportioned. You can direct that taxes be divided proportionally based on the value of each beneficiary’s share or designate specific assets to be used to satisfy tax obligations.

Income Tax Consequences

Another common pitfall occurs when people misunderstand the income tax consequences associated with inherited assets. Many people believe that an inheritance is entirely free from taxation. While beneficiaries generally do not pay tax simply for receiving property, the income generated by inherited assets often remains subject to taxation, a distinction that is frequently overlooked during estate planning.

When beneficiaries inherit assets such as savings accounts, brokerage accounts, rental properties, or business interests, any income produced after the transfer is typically taxable. Interest, dividends, rental income, and business profits must be reported on the beneficiary’s personal tax return. Without careful planning, beneficiaries may be unprepared for these ongoing tax obligations.

Retirement accounts introduce additional complexity because traditional IRAs and 401(k) accounts consist of funds that have not been taxed as income. When these accounts pass to beneficiaries, however, distributions are generally taxed as ordinary income. Changes in federal law have also altered the rules governing required distributions from inherited retirement accounts, often accelerating the timeline and increasing the tax burden on beneficiaries.

Can We Help You Avoid Tax Pitfalls in Your Indiana Estate Plan?

For more information, please join us for an upcoming FREE seminar. If you would like assistance avoiding common tax pitfalls in your Indiana estate plan, contact the experienced Indianapolis estate planning lawyers at Frank & Kraft by calling (317) 684-1100 to schedule an appointment.

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