How Taxes Can Derail Your Probate Litigation Case: Complete Guide

The Quick Answer: Tax Consequences Can Undermine Settlements,

Delay Distributions, or Reduce Your Recovery

Taxes are often an afterthought in probate litigation—but they shouldn’t be. Whether you're negotiating a settlement, challenging a will, or seeking to recover assets from a trustee, failing to account for taxes can cost you time, money, and legal leverage.

At Moravec, Varga & Mooney, we regularly advise beneficiaries, trustees, and heirs on how to structure probate litigation strategies and settlement agreements with California and federal tax liabilities in mind. If taxes are ignored, a “win” in court can turn into a loss in your pocket.

Common Tax Pitfalls in Probate and Trust Disputes

1. Capital Gains Taxes on Inherited Property

Litigants often overlook step-ups in basis rules. If the property is sold before the estate is properly administered—or if the sale is structured poorly in a settlement—it can trigger unexpected capital gains.

For example:

• Selling the property without confirming the date-of-death value

• Distributions made in-kind to heirs who later sell for a higher gain

• Mischaracterizing sales as part of a trust settlement

2. Property Tax Reassessments

In California, Proposition 13 generally protects property from reassessment—unless ownership changes. During litigation, transfers to siblings or heirs not exempt from reassessment can trigger massive property tax increases.

If a settlement divides property in a way that violates Propositions 58 or 19, taxes can spike.

💡 Tip: Always evaluate whether the parent-child exclusion or interspousal transfer exclusion applies before finalizing property-related settlements.

3. Estate and Fiduciary Income Taxes

Even if an estate isn’t large enough to trigger federal estate tax, the income tax on trusts or estates (Form 1041) can still be significant—especially for assets that generate income during long litigation.

You may be required to file:

• IRS Form 1041 for fiduciary income

• IRS Form 706 for estate tax (rare, but critical in high-value estates)

Ignoring this step can result in IRS penalties and create liability for the trustee or administrator.

4. Settlement Agreements That Shift Tax Burdens

Settlements involving buyouts, reassignments of property, or disclaimers can create taxable events. For instance:

• A cash payout to buy out a sibling’s interest in inherited property may be treated as a sale, not a distribution.

• Disclaiming an inheritance may shift the asset to someone with a higher tax exposure.

5. Penalties for Late Tax Filings

Litigation can cause administrative delays in filing returns, issuing K-1s, or completing required trust accountings. This can expose trustees, executors, and even beneficiaries to interest, penalties, or legal liability.

How to Protect Yourself from Tax Surprises

✔️ Involve a probate attorney early – We anticipate and mitigate tax consequences during litigation strategy and settlement negotiation.

✔️ Coordinate with tax professionals – In many cases, we work alongside CPAs and estate tax specialists to ensure compliance.

✔️ Structure settlements carefully – Don’t sign off on a deal that might lead to reassessment or unintended tax exposure.

✔️ Request accountings – You have a right to financial transparency. Poor tax planning often accompanies mismanagement.

Get Trusted Legal Advice Before You Finalize Your Case

Taxes can easily derail your probate litigation—even when the legal issues are resolved. At Moravec, Varga & Mooney, we understand how tax exposure intersects with estate and trust disputes, and we help clients plan accordingly.

📞 Schedule a consultation to protect your recovery and minimize your risk.