INCOME SPLITTING AFTER DEATH

Testamentary Trust - There used to be an excellent way to split income after death by creating a testamentary trust in your will. Formerly, a testamentary trust was taxed separately and like an individual taxpayer, there were graduated rates (but no personal exemption). This was such a nice way to reduce taxes that the government changed the rules such that testamentary trusts are now taxed at the top marginal rate. Therefore, do not use a testamentary trust for this purpose (there may be other valid reasons to have a testamentary trust). However, if we don’t have a testamentary trust, we can still take advantage of the graduated rates for an estate, which are available for 3 years after the death of the taxpayer. We do this by holding the estate open, and not distributing the capital until the 3 years has expired.

Let's look at an example:
Laura is 80 years old and has 3 grown children, all of whom have high taxable incomes (over $120K). Laura’s total capital is $3 million. If she leaves 1/3 to each child, each of them will be paying tax at the top rate on the additional income from their inherited capital. If we assume that this capital would generate a taxable income of 4% or $40,000 each, the children will pay an additional tax of $17,900 each per year. But if Laura's estate is held open for 3 years, then the estate would pay tax at the graduated rate. The estate would pay tax of $35,000 per year and thus the family would save $18,700 ($17,900 times 3 = $53,700 - $35,000) over the 3 years when the estate is left open. If one of the beneficiaries needs all or a portion of their capital, that’s not a problem, because the executors can always distribute a portion of the estate whenever they decide.
Keep in mind that the estate will have to file a tax return every year while open, which will probably cost $250 to $400 per year, but the tax savings make this expense well worth it.