A client recently came to my Manhattan office confused. His mother had passed away, and he was serving as both the executor of her will and the trustee of her living trust. He had prepared to file the estate tax return, but then a Form K-1 arrived from the trust’s accountant. “I thought the trust was supposed to avoid taxes,” he said, sliding the paper across my desk. “What is this?”
His question is common. It points to a fundamental—and costly—misunderstanding of how estates and trusts are taxed. They are not the same. One is a one-time tax on the transfer of a lifetime’s assets; the other is an annual tax on income generated by assets held for beneficiaries. Treating them as interchangeable can lead to surprises for the people you’ve chosen as stewards of your legacy.
The Estate Tax: A Final Accounting
The estate tax—at both the federal and state level—is a tax on the value of everything you own at the moment of your death. Think of it as a final tally. An executor inventories all assets—real estate, investment accounts, personal property. After debts and administrative expenses are paid, this net value is subject to tax if it exceeds certain exemption thresholds.
In New York, this is a critical calculation. As of 2024, the New York State estate tax exemption is $6.94 million. While that may sound high, property values alone can place many families closer to that line than they realize. New York also has a “cliff.” If the value of your taxable estate is more than 105% of the exemption amount, you do not just pay tax on the overage—the entire estate becomes subject to the tax. This is a punitive detail that requires deliberate planning to avoid.
The legal basis for this is found in New York Tax Law § 952, which ties our state’s estate tax framework to federal definitions but establishes our own rates and exemptions. The estate tax is paid once, by the estate itself, before any assets are distributed to heirs. It is a final act of closing the books on a person’s financial life.
Trust Income Tax: An Ongoing Duty
A trust is a separate legal entity designed to hold and manage assets over time. Because it can own income-producing property—stocks that pay dividends, rental properties that generate cash flow, bonds that pay interest—it has its own tax obligations. This income is what triggers the trust’s annual tax filings.
Unlike the one-time estate tax, the income tax is an ongoing responsibility for the trustee. Each year, the trust must report all income it has earned. How that income is taxed depends on the trust’s structure and actions:
- If the trust distributes its income to the beneficiaries, it passes the tax liability along with it. The beneficiaries receive a Form K-1 detailing their share of the income, which they then report on their personal tax returns.
- If the trust retains the income, it must pay the tax itself. The tax rates for trusts are highly compressed, meaning they reach the highest marginal tax bracket much more quickly than an individual would. Retaining income inside a trust can be a very inefficient tax strategy.
This is the fiduciary duty of the trustee—to manage these assets and their tax consequences prudently for the good of the beneficiaries. It is not a one-time calculation but a continuing, year-over-year responsibility.
Where the Two Tax Systems Intersect
The most common point of confusion is the role of a revocable living trust. Many people create these trusts believing they have removed assets from their estate for tax purposes. This is a critical misunderstanding.
Because you retain control over the assets in a revocable trust during your lifetime—you can change it, amend it, or dissolve it entirely—the IRS and New York State still consider those assets part of your taxable estate upon your death. The trust is an excellent tool for avoiding the probate process in Surrogate’s Court and managing assets, but it does not, by itself, solve an estate tax problem.
To remove assets from your taxable estate, you need to use an irrevocable trust. By placing assets into an irrevocable trust, you are giving up control and ownership. This is an advanced strategy, used when potential estate tax liability is a significant concern. It is a powerful tool, but it requires a permanent commitment and is not the right step for every family.
Distinguishing between these two tax systems is essential for effective stewardship. Your executor handles the one-time estate tax; your trustee manages the ongoing income tax. Understanding both is the first step toward building an intentional legacy.
If you are acting as an executor or trustee and are uncertain about your tax filing duties, or if you would like to review how your own estate plan accounts for these distinct tax obligations, I invite you to schedule a confidential review of your documents with our firm.
