Differentiating between probate and non-probate assets is essential when planning an estate. A simple way to tell them apart is to ask whether the asset’s title or beneficiary designation automatically directs distribution to named beneficiaries at the owner’s death. Typical probate assets include real property owned outright or as tenancy-in-common, bank or brokerage accounts that are not jointly titled, interests in corporations or partnerships, and tangible personal property such as jewelry and automobiles. Typical non-probate assets include jointly held real estate, life insurance policies (unless the estate is the listed beneficiary), qualified retirement accounts like IRAs, 401(k)s and pension plans, bank or brokerage accounts with payable-on-death or transfer-on-death designations, and trust-held interests that pass according to the trust terms at death.
Both probate and non-probate assets together form the gross taxable estate. It is important for the estate planning team to prepare a comprehensive inventory of all assets so the ultimate distribution aligns with the client’s intentions. Because a substantial portion of many estates consists of non-probate assets that pass outside the will, failing to account for those assets can undermine an otherwise sound estate plan. Understanding which assets are probate versus non-probate is also crucial when drafting an estate tax allocation clause in the will or in a will substitute such as a revocable trust.
For many clients, the estate tax allocation clause is one of the most important and sometimes the most complex provisions in their dispositive documents. Attorneys should discuss with clients not only estate tax consequences but also possible income tax and generation-skipping transfer tax implications. Yet some practitioners, even after spending time on tax reduction strategies, select an allocation method without fully consulting the client, and drafting mistakes or omissions can produce unintended and harmful results.
The planning team and client must decide whether all estate taxes, including those attributable to non-probate assets, should be paid from the residue of the probate estate or whether beneficiaries who receive non-probate assets and those who receive specific (pre-residuary) bequests should bear a proportionate share of the tax burden. In many cases clients expect that beneficiaries of personal property and of specific gifts will receive those assets free from reductions for estate taxes.
When a residuary estate will benefit both charitable and non-charitable beneficiaries, clients commonly intend that only the non-charitable beneficiaries bear estate taxes. Clear drafting is needed to ensure the tax burden is allocated in a way that reflects the client’s objectives.
If an attorney does not address tax apportionment, drafts the allocation clause improperly, or fails to include all taxable assets in the analysis, the result can be that statutory defaults or unintended provisions control distribution. That outcome effectively allows the attorney’s drafting choices—rather than the client’s intent—to determine the dispositive plan. Conversely, if the estate is not subject to federal or state estate tax or if the same beneficiaries receive both probate and non-probate assets in identical proportions, an allocation clause may be less significant.
Just as state intestacy statutes provide a default distribution plan for those who die without a will, state law also supplies default rules for apportioning estate taxes when a will is silent. Those statutory rules often allocate tax liability proportionally according to the asset class, which in many cases produces a fair result compared with charging the entire tax to the residuary estate. Nevertheless, statutory defaults may not reflect a particular client’s goals.
In short, any client whose estate may be subject to estate taxes should have a carefully considered estate tax allocation provision in their will or trust. Such a provision should be tailored to the client’s objectives and drafted clearly so that the tax consequences align with the client’s intended distributions.