(Dow Jones) Few things get people madder at their estate planners than fights over who must pay taxes when someone dies. A big source of trouble: the patchwork of state rules that apply.

Most states say those who inherit have to share the tax burden for an estate. Many wills include provisions designed to take care of that problem, but these can sometimes produce unpleasant surprises. A recent Wisconsin Supreme Court decision shows the lack of coherence among states and the problems that can ensue.

Wisconsin says taxes must be paid from a single pot of money in an estate. (Georgia, Iowa and Arizona have similar laws.) But when James F. Sheppard died and left a goddaughter, Jessica Schleis, over $3.7 million, the estate sought to get her to pay taxes on her inheritance.

Sheppard, co-founder of a sandwich chain, was worth $12 million when he died in 2007, but had no will. He left the money to Schleis in two special accounts, one known as a "Payable on Death" account, and the other in a "Transfer on Death" account. A Wisconsin court held the estate, not Schleis, responsible for the tax and last week the state's highest court affirmed that ruling after an appeal.

All of the trouble could have been avoided had Sheppard had a will -- but only if such a will "did the right thing" in spelling out details, said Jeffrey N. Pennell, a law professor at Emory University School of Law.

A typical will contains an instruction that all debts, expenses and taxes be paid from what's left of an estate after the heirs get the money or property bequeathed to them. Pennell calls it the "Dad-buys-dinner" provision, as when a father picks up the tab for the entire family at a restaurant.

This approach often creates problems, as it did in the Sheppard case. So most states have default laws that apportion taxes among all the beneficiaries, an approach Pennell calls "Dutch treat."

As a general matter, a will can trump the state default rules on who gets what and who owes what taxes from an estate. Still, after decades of studying estate law, Pennell believes that more "estate meltdowns" spring from the "Dad-buys-dinner" provision than from any other.

The issue is only growing more acute as people transfer assets outside of wills through vehicles such as life insurance, leaving less in the estate to cover tax obligations and complicating the issue of who owes how much in taxes. Non-probate transfers have been on the upswing over the past decade, according to Jeffrey A. Cooper, an associate professor of law at Quinnipiac University School of Law and formerly a tax partner at law firm Cummings & Lockwood.

If a person "goes out and buys life insurance, for a child, a lover or a loyal employee, that has tax implications for everyone," said Cooper.

First « 1 2 » Next