Summary
- Estate tax payments (Form 706 and state inheritance taxes) are client expenses, not firm expenses—recording them incorrectly creates phantom income, inflates your tax liability, and distorts profitability metrics
- The critical distinction is between estate funds and firm funds: when your firm advances or processes tax payments on behalf of an estate, the transaction flows through asset or liability accounts—never through your P&L
- A properly configured QuickBooks setup with legal-specific integrations can reduce estate tax accounting errors by 90% while ensuring compliance with both IRS requirements and state bar trust accounting rules
You’ve just filed a $2.4 million Form 706 estate tax return for a complex estate matter. The IRS payment cleared three days ago. But when you pull up your firm’s profit and loss statement, something looks terribly wrong.
That seven-figure tax payment is sitting there as an expense—crushing your profitability numbers, inflating your operating costs, and creating an accounting nightmare that will haunt you at tax time.
If this scenario sounds familiar, you’re not alone. Estate law firms across the country struggle with one of the most misunderstood aspects of legal accounting: how to properly record estate tax payments in QuickBooks without corrupting their own financial statements.
The stakes are high. Get it wrong, and you’re looking at IRS scrutiny, distorted financial reports that undermine strategic decisions, and potentially even state bar trust accounting violations. Get it right, and you’ll have clean books, accurate profitability metrics, and the peace of mind that comes from knowing your accounting is bulletproof.
Why Estate Tax Accounting Is Different (And Why Most Firms Get It Wrong)
The Fundamental Problem: Whose Money Is It?
Estate law creates a unique accounting challenge that most practice areas don’t face. When your firm handles an estate matter, you’re often managing two completely separate sets of finances:
Your Firm’s Finances
- Your legal fees
- Operating expenses
- Trust account balances
The Estate’s Finances
- Estate assets and liabilities
- Tax obligations (Form 706, state estate taxes, inheritance taxes)
- Distributions to beneficiaries
The confusion starts when these two financial worlds intersect—which happens constantly in estate practice. Your firm might advance filing fees, process tax payments from estate accounts, or hold estate funds in trust pending distribution.
Every one of these transactions creates an opportunity for accounting errors that can cascade through your financial statements for years.
The $13.99 Million Threshold (And Why It Matters Less Than You Think)
In 2025, the federal estate tax exemption stands at $13.99 million per individual—meaning estates below this threshold generally don’t owe federal estate tax. But here’s what many firms miss: even estates that don’t owe federal tax often require Form 706 filings for portability elections, and state-level obligations create complexity regardless of federal thresholds.
Consider the landscape of state estate and inheritance taxes. Twelve states and Washington, D.C. impose estate taxes, with exemption thresholds ranging from just $1 million in Oregon and Massachusetts to $7.16 million in New York. Meanwhile, five states—Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania—levy inheritance taxes on beneficiaries regardless of estate size.
Maryland stands alone as the only state imposing both an estate tax and an inheritance tax, creating particularly complex accounting requirements for firms handling estates with Maryland connections.
The practical reality? Even mid-sized estate practices routinely process significant tax payments that must be recorded correctly to maintain accurate firm financials.
Form 706: What It Is and Why Recording It Wrong Destroys Your P&L
Understanding the 706 Payment Lifecycle
Form 706, the United States Estate (and Generation-Skipping Transfer) Tax Return, serves as the primary federal estate tax filing. When an estate owes tax, the executor must ensure payment within nine months of the decedent’s death (with extensions available).
The payment typically flows through one of several channels, each with distinct accounting implications:
Payment from Estate Bank Account The executor pays directly from estate funds—never touches your firm’s books except as a notation.
Payment from Firm Trust Account Estate funds held in your IOLTA are used to pay the tax—requires trust accounting entries but shouldn’t affect your P&L.
Advanced Payment by Firm Your firm fronts the payment and seeks reimbursement—creates an asset on your books until collected.
Here’s where firms go wrong: they record the tax payment as an expense. This single error has three devastating consequences.
First, it artificially inflates your firm’s operating expenses by potentially millions of dollars. Second, it creates phantom deductions that the IRS may challenge. Third, it destroys your ability to accurately measure practice area profitability.
The Correct Accounting Treatment
The IRS is clear on this point: when a law firm advances funds on behalf of a client (or an estate), those payments are not deductible expenses. They’re loans—assets on your balance sheet—until the client reimburses you or you write them off as uncollectable.
This treatment applies whether you’re paying a $50 filing fee or a $5 million estate tax bill. The principle doesn’t change with the dollar amount.
In QuickBooks, this means:
When You Advance the Payment:
- Debit: Advanced Client Costs (Asset Account)
- Credit: Operating Bank Account
- Associate with: Specific estate/matter
When You’re Reimbursed:
- Debit: Operating Bank Account
- Credit: Advanced Client Costs (Asset Account)
If the Amount Is Never Collected:
- Debit: Bad Debt Expense
- Credit: Advanced Client Costs (Asset Account)
Notice what’s happening here: the payment never touches your income statement until you’re reimbursed (net zero effect) or you write it off (legitimate deductible loss). Your P&L stays clean, and your financial statements accurately reflect your firm’s actual economic activity.
State Estate and Inheritance Taxes: A Multi-Jurisdictional Headache
The State Tax Landscape in 2025
Federal estate tax is only part of the picture. Twelve states plus D.C. impose their own estate taxes, with exemption thresholds ranging from just $1 million (Oregon) to $13.99 million (Connecticut). Washington recently raised its top estate tax rate from 20% to 35%.
Meanwhile, five states—Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania—levy inheritance taxes on beneficiaries. Maryland alone imposes both taxes, creating particularly complex accounting requirements.
Recording State Tax Payments Correctly
The accounting principles for state tax payments mirror federal treatment, but with additional complications.
When the Estate Pays Directly: No entry in your firm’s books beyond notation in your matter management system.
When Paying from Trust Funds: The payment flows through your trust liability accounts—reducing the client’s trust balance without affecting your operating accounts or P&L.
When Your Firm Advances Payment: Record as an asset (Advanced Client Costs), associated with the specific matter, and reduce when reimbursed.
The critical point: state tax payments are never your firm’s expense unless you’ve agreed to absorb them as part of a fee arrangement—which would be highly unusual.
Setting Up QuickBooks for Estate Tax Accounting
Your Chart of Accounts: The Foundation
A properly structured chart of accounts makes estate tax accounting straightforward. Here’s the framework that works:
Asset Accounts
- Advanced Client Costs (Parent Account) with sub-accounts for Filing Fees, Expert Fees, Tax Payments Advanced
Liability Accounts
- Funds Held in Trust (Parent Account) with client sub-accounts for each matter
- Estate Funds Held in Trust (Separate from client retainers)
Income Accounts
- Legal Fee Income
- Reimbursed Client Costs Income (if you bill with markup)
Expense Accounts
- Bad Debt Expense (for uncollectable advances)
Notice what’s NOT on this list: an expense account for estate tax payments. There shouldn’t be one.
Critical QuickBooks Settings
QuickBooks Online doesn’t come configured for legal accounting out of the box. You need to enable specific features and customize settings to handle estate tax tracking properly.
Navigate to Settings → Account and Settings → Expenses, and ensure that “Track billable expenses and items as income” is enabled. This setting ensures that when clients reimburse advanced costs, the transaction flows correctly through your accounts.
Next, establish clear naming conventions for your matters. Estate matters should be immediately distinguishable from other client work, and tax-related transactions need descriptive memos that specify which form or obligation the payment addresses.
The Three-Way Reconciliation Requirement
For payments involving trust funds, your accounting must support three-way reconciliation—matching your firm’s internal records, bank statements, and client ledgers. When you process an estate tax payment from trust funds, all three must reflect the transaction simultaneously. Any discrepancy creates audit risk and potential bar complaints.
This is where legal-specific software integration becomes valuable. Integrated systems ensure single entries propagate correctly across all records.
The Trust Account Trap: Why Estate Funds Require Special Handling
When Estate Funds Land in Your Trust Account
Estate matters frequently involve your firm holding substantial funds. The fundamental rule: estate funds held in trust are not your money. They exist as a liability on your balance sheet—an obligation to disburse according to the estate plan and applicable law.
When you use trust funds to pay estate taxes, you’re reducing that liability while simultaneously reducing your trust bank account. Your P&L remains untouched.
The journal entry:
- Debit: Trust Liability – [Estate Name] (reduces what you owe the estate)
- Credit: Trust Bank Account (reduces the cash you’re holding)
This entry has no P&L impact. That’s exactly right.
The Commingling Catastrophe
Nothing will end your legal career faster than commingling client funds with firm funds. Never pay an estate tax obligation from your operating account unless you’re intentionally advancing the funds and expect reimbursement.
Establish workflows that require verification before any tax payment processes. The person initiating payment should confirm the funding source. The person approving should verify independently. Learn more about trust accounting best practices to protect your practice.
Practical Workflows for Estate Tax Recording
Workflow 1: Estate Pays Directly (No Firm Involvement)
The simplest scenario. The estate has its own bank account and pays directly.
Your Accounting Requirement: None for the payment itself. Maintain records in your matter management system, but don’t create QuickBooks entries affecting your firm’s financial statements.
Workflow 2: Payment from Trust Funds
The estate has deposited funds with your firm, and you’re authorized to pay from those funds.
- Verify Sufficient Balance before initiating payment
- Process Payment from trust account to tax authority
- Record Transaction in QuickBooks from trust bank, coded to estate’s trust liability sub-account
- Update Client Ledger with date, amount, payee, and purpose
Common Error: Recording against an expense account instead of trust liability.
Workflow 3: Firm Advances Payment
Your firm pays from operating funds, expecting reimbursement.
- Record Advance from operating account to Advanced Client Costs (asset), associated with specific matter
- Invoice for Reimbursement ensuring advanced cost pulls through correctly
- Receive Payment against invoice; QuickBooks reduces your Advanced Client Costs asset
- Verify Net Zero P&L Impact after reimbursement
Common Error: Treating advance as expense and reimbursement as income, inflating both sides of your P&L.
Avoiding the Most Expensive Mistakes
Mistake 1: Recording Tax Payments as Operating Expenses
We’ve covered this, but it bears repeating because it’s the most common and most damaging error. Estate tax payments—whether federal or state—are never your firm’s operating expense unless you’ve explicitly agreed to absorb them.
The Fix: Use Advanced Client Costs (asset) for payments you advance, or Trust Liability reductions for payments from trust funds. Never use expense accounts.
Mistake 2: Failing to Associate Payments with Specific Matters
When you record an estate tax payment without associating it with the correct estate matter, you lose the ability to track which estates have outstanding advances and which are fully reimbursed.
The Fix: Every payment should reference a specific client/matter. In QuickBooks, use the Customer field consistently, matching your matter management naming conventions.
Mistake 3: Mixing Estate Accounting with Firm Accounting
Your firm should maintain one QuickBooks file for your firm’s finances. The estates you administer should maintain separate accounting—either through separate QuickBooks files, specialized fiduciary accounting software, or professional fiduciary services.
When firms try to track estate assets, liabilities, and distributions within their own QuickBooks file, confusion inevitably follows. Your firm’s balance sheet shouldn’t include estate assets that you’re merely administering.
The Fix: Maintain strict separation. Your QuickBooks file tracks your firm’s relationship with the estate (fees earned, costs advanced, trust funds held). The estate’s own accounting tracks everything else.
Mistake 4: Ignoring State-Specific Requirements
A client with property in Illinois, residency in New York, and beneficiaries in Pennsylvania faces three different tax regimes. Your accounting must track which payments go where, which deadlines apply, and which estates have completed their obligations.
The Fix: Create matter-specific notes or custom fields that identify which state obligations apply to each estate. When recording payments, include the specific form or tax type in the memo field.
Mistake 5: Neglecting Documentation
When the IRS or a state bar examiner reviews your records, they need to understand exactly what happened and why. Vague transaction descriptions create questions that you may struggle to answer years later.
The Fix: Every estate tax payment entry should include the form number (706, state equivalent), the estate name, the tax year, and the payment method. “Tax payment” is insufficient; “Form 706 payment for Estate of Jane Smith, DOD 3/15/2024, EFTPS confirmation #12345” is appropriate.
Integration: The Missing Piece
Why QuickBooks Alone Isn’t Enough
QuickBooks is powerful accounting software, but it wasn’t designed for law firms. The challenges include matter-centric accounting, trust accounting compliance, time tracking integration, and legal-specific reporting.
For estate practices, the reporting gap is particularly significant. You need to know which estates have outstanding advances and pending tax obligations. That information exists across multiple accounts and matters, requiring either manual compilation or purpose-built reports.
What Integration Provides
Legal billing and accounting platforms designed to work with QuickBooks address these gaps with automatic trust compliance, matter-centric reporting, advanced client cost tracking, and seamless synchronization.
The result: less time on administrative accounting and more confidence in your records’ accuracy.
Building Your Estate Tax Accounting Checklist
Before recording any estate tax payment, walk through these verification steps:
Source of Funds Verification
- [ ] Identified whether payment comes from trust, operating, or estate’s own account
- [ ] Confirmed sufficient funds available in the source account
- [ ] Verified no commingling issues
Transaction Recording
- [ ] Selected correct account type (asset for advances, trust liability for trust payments)
- [ ] Associated with specific estate matter
- [ ] Included comprehensive memo/description
- [ ] Attached supporting documentation
Compliance Verification
- [ ] Three-way reconciliation completed (for trust payments)
- [ ] Client ledger updated
- [ ] Matter notes updated with payment confirmation
Post-Recording Review
- [ ] Confirmed no P&L impact from trust/advance payments
- [ ] Verified matter balance reflects outstanding advances
- [ ] Reconciled bank account
The Bottom Line
Estate tax accounting isn’t complicated once you understand the fundamental principle: estate tax payments are not your firm’s expenses. They’re either reductions in trust liabilities (when paid from client funds) or assets awaiting reimbursement (when your firm advances payment).
Get this right, and your financial statements accurately reflect your firm’s actual economic activity. Your profitability metrics become meaningful. Your tax returns require no awkward explanations. Your state bar auditors find nothing concerning.
Get it wrong, and you’re facing distorted financials, potential IRS scrutiny, and the nagging uncertainty that comes from knowing your books don’t tell the true story of your practice.
The firms that thrive in estate practice are the ones that master the operational details—including accounting. Because at the end of the day, your legal expertise matters most to your clients. But your accounting accuracy determines whether you’ll be around to serve them.
FAQ
Q: What if the estate doesn’t reimburse us for an advanced tax payment? A: If you’ve advanced an estate tax payment and cannot collect reimbursement (rare in estate practice, but possible with insolvent estates), you write off the advance as a bad debt expense. At that point—and only at that point—the amount becomes a deductible expense on your firm’s books.
Q: Should state inheritance taxes paid by beneficiaries go through our firm’s books? A: Generally, no. Inheritance taxes are the beneficiary’s obligation, not the estate’s. If your firm processes the payment on behalf of a beneficiary, treat it identically to any client advance—as an asset until reimbursed. But in most cases, beneficiaries pay their own inheritance tax obligations directly.
Q: How do we handle estates with property in multiple states? A: Track each state’s obligations separately within the matter. When recording payments, specify which state’s tax is being paid. Some firms create sub-matters for multi-state estates to maintain cleaner records, though this adds administrative overhead.
Q: What if we’re appointed as executor and our firm handles the estate’s finances? A: When your firm serves as executor, maintain strict separation between your firm’s QuickBooks file (tracking legal fees and your firm’s finances) and the estate’s accounting (tracking estate assets, liabilities, and tax obligations). Many firms use specialized fiduciary accounting software or engage professional fiduciary services to avoid conflicts.
Q: Do portability elections require the same accounting treatment as actual tax payments? A: Portability-only 706 filings typically involve no tax payment—only the filing fee. Record that fee as you would any filing fee: as an advanced client cost if your firm pays, or not at all if the estate pays directly. The accounting treatment follows the payment, not the form’s purpose.
Sources
- “Instructions for Form 706 (Rev. September 2025).” Internal Revenue Service. https://www.irs.gov/instructions/i706
- “Estate and Inheritance Taxes by State, 2025.” Tax Foundation, November 2025. https://taxfoundation.org/data/all/state/estate-inheritance-taxes/
- “2025 State Estate Tax and Inheritance Tax Chart.” American College of Trust and Estate Counsel, April 2024. https://www.actec.org/resources-for-wealth-planning-professionals/state-death-tax-chart/
- “Frequently Asked Questions on Estate Taxes.” Internal Revenue Service. https://www.irs.gov/businesses/small-businesses-self-employed/frequently-asked-questions-on-estate-taxes
- “2025 Federal & State Estate and Gift Tax Cheat Sheet.” Wealthspire Advisors, February 2025. https://www.wealthspire.com/guides-whitepapers/federal-state-estate-gift-tax/
