How To Split Inheritance And Minimize Taxes

The expensive mistake: dividing assets without reading the tax map

Here’s the part most families miss: what you give matters as much as how much you give. Split everything 33/33/34 and it looks fair, until your highest-earning child inherits the traditional IRA and ends up paying the tax bill nobody priced in. I’ve watched otherwise well-constructed plans wobble because the asset types went to the wrong people. And yeah, I’ve made that spreadsheet at 11:30pm and realized I was solving for symmetry, not after-tax outcomes. Different game.

Why this matters right now? We’re in Q4, and estate plans are getting dusted off before year-end gifts. Rates are still meaningfully higher than the 2010s, markets have been choppy this year, and taxes haven’t gotten kinder. Equal on paper can turn unequal after tax. Two quick anchors for the real world:

• Pre-tax accounts = future income taxes for heirs. Most non-spouse heirs must empty inherited IRAs and 401(k)s within 10 years under the SECURE Act (effective 2020). Distributions are ordinary income. If your heir sits in the 37% top federal bracket in 2025, that IRA is really a joint asset with the IRS.
• Brokerage assets often get a step-up in basis at death. That means embedded gains can reset to fair market value, frequently wiping out years of taxable appreciation for heirs when they sell. Different pocket, different tax math.

Small stat check so we keep our feet on the ground: as of 2024, the federal estate tax exemption was $13.61 million per person (indexed annually). It’s scheduled to drop roughly in half on Jan 1, 2026 unless Congress acts. Also as of 2024, 12 states plus D.C. had estate taxes, and 6 states had inheritance taxes, state rules can bite unexpectedly if you or your heirs live in one of them. I know, it’s a lot of map-reading. But ignoring it is pricier.

Equal isn’t always fair after tax, asset type, basis, and beneficiary tax bracket change outcomes.

What you’ll get from this section (and the whole how-to-split-inheritance-and-minimize-taxes problem we’re solving):

1. How different buckets behave: pre-tax (IRAs/401(k)s), after-tax with basis (brokerage), and tax-free (Roth, sometimes life insurance).
2. Why matching assets to heirs is smarter than locking in pretty percentages. Charities love IRAs (they pay zero tax). High earners prefer step-up assets. Lower-bracket heirs can absorb more IRA income. Trusts and entities have their own brackets, careful there.
3. What the 2026 estate tax sunset means for gifting, beneficiary designations, and whether you pre-pay or shift taxes while exemptions are still higher.

Quick enthusiasm spike here because this is where plans actually save money: asset location across heirs. I just wrote “marginal rate optimization” and winced, sorry, what I mean is, put the taxable stuff where it hurts least. If one heir is a physician in a high-tax state and another is taking time off with kids in a lower bracket, the same $1 million IRA hits wildly differently.

We’ll keep a humble stance. Tax law moves, families are messy, markets swing. But your plan can be designed to bend, not break: assign the right assets to the right people, then, and only then, settle the percentages. And yes, keep that 2026 sunset blinking on your dashboard.

Sort the buckets: taxable, tax‑deferred, tax‑free, very different after death

You don’t cut the tax bill by guessing. You cut it by knowing how each bucket behaves the second ownership changes, because the rules flip on you at death and the differences are big.

• Taxable brokerage: Most positions get a step‑up in basis at death under IRC §1014. That means heirs can sell near-zero gain if they sell close to the date-of-death value. In high-appreciation years, that’s real money. Top federal long‑term capital gains is 20% plus the 3.8% NIIT for high earners (23.8% total, current law), so wiping the embedded gain matters. In community property states, AZ, CA, ID, LA, NV, NM, TX, WA, WI, couples often get a double step‑up when the first spouse dies. Separate property states usually don’t; state law and titling decide it. I’ve seen this swing six-figure tax outcomes, same portfolio, different state lines.
• Tax‑deferred (traditional IRA/401(k)): This is income in respect of a decedent (IRD). There’s no step‑up on the income. Heirs pay ordinary income tax when funds come out. Under the SECURE Act (2019) and IRS guidance through 2024, most non‑spouse beneficiaries fall under the 10‑year rule. If the decedent died after their required beginning date, annual beneficiary RMDs may apply inside that 10‑year window, IRS has been easing penalties during the transition, but the income still lands on the heir’s return. With the top federal ordinary rate at 37% in 2025, timing and whose bracket absorbs the IRA dollars is everything.
• Roth IRA: Inherited Roths usually follow the same 10‑year clock for non‑spouse heirs, but qualified withdrawals are tax‑free. No step‑up needed because there’s no IRD. The trick is just to respect the 10‑year window. If the original owner hadn’t met the 5‑year rule before death, you may need to wait on earnings, details matter, and they matter a lot.
• HSAs: These are sneaky. Spouses can treat an inherited HSA as their own. Non‑spouse beneficiaries don’t get a rollover, the HSA becomes taxable to them in the year of death, except they can offset with any last qualified medical expenses of the decedent. It’s a one‑year tax event, not a 10‑year drip.
• Life insurance: Death benefits are generally income‑tax‑free under §101(a). But they’re included in the estate if the decedent owned the policy (incidents of ownership). That’s why people use ILITs, own the policy outside the estate so the proceeds aren’t pulled into the estate tax calculation.

Two quick context notes I’m thinking about as I write this in Q4: equities had a strong run last year and parts of this year, so lots of embedded gains sit in taxable accounts, great candidates for step‑up. Meanwhile, big IRAs are basically future ordinary income for someone. Same dollars, different taxes, said differently, the bucket matters more than the label on the account statement.

Personal note: I had a case in Austin, community property, where a $2.4 million stock portfolio got a full double step‑up at the first death. Heirs later sold with roughly $12k of total realized gain. Same family had a $1.1 million traditional IRA that we spread over 7 tax years across two lower‑bracket kids. The contrast was…stark.

One more repeat because it’s that important: taxable gets a step‑up (maybe double in community property), tax‑deferred is IRD taxed at ordinary rates under the SECURE 10‑year framework, Roth is usually 10‑year but tax‑free on qualified withdrawals, HSAs are a near‑term tax hit for non‑spouse heirs, and life insurance is income‑tax‑free but can be an estate tax problem unless parked in an ILIT. Sort the buckets first, percentages after.

Match assets to heirs: who should get what (and why)

If one child is a surgeon in the 37% bracket and the other is a teacher in the 12% bracket, handing both the same traditional IRA is… not optimal. Same dollars, wildly different after-tax outcomes. The SECURE Act’s 10‑year payout rule (2019) turned pre‑tax IRAs into short, taxable annuities for most non‑spouse beneficiaries. Which means your beneficiary’s marginal rate is the fulcrum. Not the account balance. Their tax rate.

Quick framework I use with families (and yes, I’ve seen this go sideways when people ignore it):

• Traditional IRAs/401(k)s (pre‑tax) → steer to lower‑bracket heirs or charities. Lower‑bracket kids can bleed the account over the 10 years with less bracket creep; charities pay no income tax on IRD, so a $500k traditional IRA to a 501(c)(3) typically yields $500k for the mission, not $500k minus ordinary income tax.
• Roth IRAs → make the higher‑bracket heirs smile. They still face the 10‑year clock, but qualified Roth withdrawals are tax‑free, so your 37%‑bracket surgeon keeps every dollar and can let it compound for most of the window.
• Taxable brokerage → step‑up in basis at death (double step‑up in some community property states). That stepped‑up basis favors heirs who may sell soon, often older heirs who prefer simplicity and cash flow.

Why the charity angle matters: charities pay a 0% income tax rate on inherited IRD, while your heirs might pay up to 37% federally, plus 3.8% NIIT if their MAGI is above the threshold (Internal Revenue Code §1411; the NIIT rate is 3.8% as enacted in 2013 and still in place this year). So a $300k traditional IRA left to a child in the 35% bracket could lose six figures to taxes over the 10‑year window; the same $300k to a charity loses $0 to income tax. That’s not a rounding error.

Age and cash‑flow also matter. A 68‑year‑old heir who plans to downsize and simplify may prefer the stepped‑up brokerage account they can sell with minimal capital gains. A 32‑year‑old who doesn’t need the money today can let an inherited Roth compound inside the 10‑year window, then take a lump sum near year 10, still tax‑free if qualified. In a year like 2025 where rates on cash are decent and markets have been choppy here and there (I’ll spare you the macro rant), flexibility is worth something.

Special case that gets botched: a disabled beneficiary. Don’t leave assets outright if means‑tested benefits are in play. Use a third‑party supplemental needs trust so you preserve eligibility and control taxes. The SSI resource limit is $2,000 for an individual (that number has been stuck there since 1989, per SSA rules), and one accidental outright inheritance can blow that up. The trust can be named as beneficiary of your IRA, Roth, and life insurance, then the trustee manages distributions to protect benefits and time taxable payouts.

Two beneficiary form switches that sound technical but are actually practical:

• Per stirpes vs per capita: If a child predeceases you, per stirpes sends their share to their kids; per capita redistributes across surviving beneficiaries. Pick intentionally. If your high‑earner child dies first and you’re per capita, the traditional IRA may shift to your other, higher‑income heirs and trigger bigger taxes than you intended.
• Charitable tail: If you want simplicity, you can make the charity a contingent or percentage beneficiary of the traditional IRA specifically, while directing Roth and brokerage to family. That’s the tax‑efficient split without hair‑splitting.

One real‑world-ish allocation I’ve used (adjust the dials to your family):

1. Teacher in the 12% bracket gets 70-100% of the traditional IRA beneficiary share and maybe less of the stepped‑up brokerage.
2. Surgeon in the 37% bracket gets Roth and a larger slice of stepped‑up brokerage.
3. Charity gets the remainder of the traditional IRA (most tax‑efficient dollars you can give at death).
4. Disabled niece/nephew: beneficiary is a special needs trust, not the person.

Is this perfect? No. There are gray areas, state taxes, the NIIT threshold, Medicare IRMAA if a surviving spouse inherits first, and the unknowns of their future income. But aligning asset type with tax profile gets you 80-90% of the way. Percentages are just math after that.

Minimize taxes in 2025: gifting, timing, and basis moves that still work

We’re in Q4 2025, the calendar is running out of pages, and the 2026 estate exemption drop is not a rumor, it’s on the books. The temporary TCJA boost sunsets after 12/31/2025, which means today’s historically high exemption gets roughly cut in half on 1/1/2026 (back to the pre‑TCJA framework, inflation‑adjusted). Translation: if you’ve been procrastinating on lifetime gifts, the clock is louder now.

1) Use the annual exclusion, cleanest dollars you’ll ever move. The annual gift exclusion is the easy button. For reference, the IRS set the 2024 exclusion at $18,000 per recipient. Confirm the 2025 figure before writing checks, it’s indexed for inflation and the IRS number is the only one that counts. Couples can “split” gifts and double it per recipient if they file the gift‑splitting election. Pro tip: if you’re 529 funding, you can front‑load five years of the annual exclusion into one contribution (the five‑year election) and still keep it out of your lifetime exemption. Just make sure the paperwork matches the math.

2) Lifetime gifts remove future appreciation. Gifting isn’t just about what leaves your estate today; it’s about what future growth you’ve kicked out. In a market that set fresh highs earlier this year (and has been choppy since late summer), moving high‑growth, high‑basis assets now can be powerful. High basis because donee takes your basis; high growth because you want that growth outside your estate. Hang on to low‑basis winners if the plan is to die with them, your heirs may get a step‑up in basis at death under current law, wiping embedded gains. Different story if you expect to sell in your lifetime; then basis planning is everything.

3) Parents in lower brackets: Roth conversions while rates are still known. If the parents are in the 12%, 22%, or 24% brackets this year, opportunistic Roth conversions can shrink the future taxable IRA that kids inherit. Pay the tax from non‑IRA funds to keep more tax‑free dollars compounding. This also shortens the SECURE Act 10‑year problem for non‑eligible beneficiaries, less to force out as taxable distributions later. Yes, market levels matter, down weeks can be a nice conversion window, but don’t get cute waiting for the perfect tick. I’ve done conversions on a Friday afternoon more than once because the calendar, not the quote, was the bigger risk.

4) Tax‑loss harvest before death or settlement. Losses do not carry over after death; they vanish. If you have realized gains this year, harvest losses now to offset them. The standard rules still apply, wash‑sale rules are unforgiving, so use similar but not “substantially identical” replacements. And yes, net capital losses can offset up to $3,000 of ordinary income per year under IRC §1211(b). If an estate settlement is on the horizon, pre‑death harvesting can be worth real money. Post‑death? Those loss carryforwards are gone.

5) Beneficiary designations and TOD/POD titles. This is the fastest, cleanest way to steer assets without probate hassle. Review every IRA, 401(k), annuity, HSA, and life insurance policy. In taxable accounts, TOD (transfer‑on‑death) and POD (payable‑on‑death) designations move assets directly. It’s admin work, yes, it’s boring, but it prevents your heirs from playing scavenger hunt with the court system.

6) Married? Portability and DSUE, don’t waste the first exemption. If one spouse dies in 2025 (or died in recent years), consider a portability election so the survivor can use the Deceased Spouse’s Unused Exclusion (DSUE), especially valuable before the exemption shrinks in 2026. The election is made on Form 706, and under Rev. Proc. 2022‑32 there’s a simplified late‑filing window up to 5 years for estates under the filing threshold. I’ve seen seven‑figure tax savings from a DSUE that cost a few thousand bucks in prep and a little patience.

Quick recap you can act on this quarter: use your 2025 annual exclusions (confirm the IRS dollar), gift high‑growth/high‑basis assets, consider Roth conversions in reasonable brackets, harvest losses to offset 2025 gains, fix beneficiaries/TODs, and if relevant, lock in portability. The 2026 sunset won’t wait for your family meeting.

Last thing, be honest about tradeoffs. Gifting removes control and basis step‑up potential; Roth conversions accelerate tax now. But with the exemption likely getting chopped next year and markets still near historically rich valuations, the arithmetic in Q4 favors action. And yes, I know “we’ll do it after the holidays.” That’s how April sneaks up on people… in December.

Trusts and titles that actually save taxes (and headaches)

Trusts aren’t about being fancy; they’re about control, taxes, and keeping Thanksgiving from turning into a probate recap. And with the higher federal exemption scheduled to sunset after 2025, using the right trust now isn’t academic. It’s math and timing. Quick framing: the federal estate tax rate tops out at 40% (same story for years), and about a dozen states plus DC still impose an estate tax, with 6 states having an inheritance tax (Maryland has both). If you’re thinking “how-to-split-inheritance-and-minimize-taxes,” this is where the rubber meets the road.

• Credit Shelter / Bypass Trust (a.k.a. Family Trust), On the first spouse’s death, you can fund a bypass trust to lock in that spouse’s exemption at today’s higher level before the 2026 reset. The surviving spouse can benefit (income, health/maintenance support), but assets and growth stay out of their estate. If you just use portability, the DSUE amount carries, but future growth is exposed to estate tax. In a choppy-but-elevated market in Q4 2025, parking growthy assets in the bypass can be a real swing factor over 10-20 years.

• QTIP Trust, Great for blended families. The surviving spouse gets all income for life and can receive principal under defined standards, qualifying for the unlimited marital deduction now, while you preserve control over who gets what later (usually the kids from the first marriage). Under IRC 2056(b)(7), you get the marital deduction but keep the remainder beneficiary locked. I’ve seen this prevent some very loud holiday arguments.

• ILIT (Irrevocable Life Insurance Trust), Life insurance proceeds are generally income‑tax free under IRC 101(a), but they’re pulled into your estate if you own the policy or have incidents of ownership (IRC 2042). An ILIT keeps proceeds outside your estate and creates liquidity right when it’s needed to pay estate or state death taxes without fire‑selling a business or low‑basis stock. With rates still relatively high this year, carriers’ crediting and guaranteed rates have been sturdier; using ILIT-owned policies to fund buyouts or equalize inheritances is working well right now.

• Disclaimer Planning, Build your documents so the survivor can choose after death. A qualified disclaimer has a hard 9‑month window (IRC 2518), and the beneficiary can’t accept benefits before disclaiming. If markets or laws shift, the survivor can redirect assets into a bypass or QTIP without rewriting history. Flexibility is underrated until you need it.

• Retirement Accounts + Trusts (SECURE‑friendly drafting), Since the 2019 SECURE Act, most non‑spouse heirs must empty inherited IRAs within 10 years</strong. Conduit trusts pass RMDs straight out to beneficiaries (cleaner timing, less tax drag), while accumulation trusts can retain withdrawals for asset‑protection… but then the trust pays tax at compressed brackets. For reference, the top trust bracket hit $14,451 of taxable income in 2024; the 2025 thresholds are only modestly higher. Point is: retaining IRA income in an accumulation trust can push you into high rates fast. Coordination between beneficiary forms and the trust text is not optional.

@article{how-to-split-inheritance-and-minimize-taxes,
    title   = {How To Split Inheritance And Minimize Taxes},
    author  = {Beeri Sparks},
    year    = {2025},
    journal = {Bankpointe},
    url     = {https://bankpointe.com/articles/split-inheritance-minimize-taxes/}
}