The big federal tax overhaul has been passed and signed into law, and now that the gift and estate exemption has been doubled to more than $11 million (or $22 million for a couple), most readers may be asking whether they still need to concern themselves with estate planning. The short answer for everyone is yes. Estate planning takes many forms—and it’s by far not only about having a large estate! But if you have given significant lifetime gifts to your heirs as a way of reducing future estate tax, the answer for you is even more emphatic—you need to take a hard look at whether you should get those gifts back.
I’ll explain. One aspect of estate planning, obviously, involves reducing your potential estate tax. This becomes less important for most Americans now that individuals and couples can leave the above large amounts estate-tax-free. However, the increased exemption is scheduled to sunset after 2025 with no guarantee that it will be extended at that time—and even before then, Congress under a new president might reduce the new, larger exemption. You can’t take anything for granted in this political climate.
The good news, for now, is that in addition to the increased exemption, Congress maintained the step-up in basis for appreciated assets. So, when a person dies with assets that have gained in value (appreciated), the presumed cost (basis) of those assets to the heir will be increased to the assets’ value on the date of death, and thus the heirs could, for example, avoid capital gains tax on the immediate sale of the inherited property (or face lesser tax when selling in the future after further appreciation). Thus, a married couple with up to $22 million in asset value could pass on the entire estate to their heirs both estate tax- and capital gains tax-free. Because of this, it is important to review whatever gifting has previously been done because the assets gifted to your family (or trusts for their benefit) will not get the stepped-up basis at your death.
Let’s look at one example to illustrate this. Dad made a gift of stock some years ago to a trust for his daughter’s benefit. The stock had a cost basis of $100,000. Dad is now 82 years old, and the stock, which the trust now owns, has a value of $500,000 (think Amazon). If daughter sells the stock after Dad dies, she will pay capital gains tax on the sale proceeds over Dad’s $100,000 cost basis…a lot of tax. However, if Dad had continued to own the stock until his death and his estate was within the exemption amount, there would be no estate tax and no capital gains tax on any appreciation up to the date-of-death value. This would result in a saving of, perhaps, at least $80,000 (assuming the date-of-death value was $500,000 and the capital gains tax rate is 20%).
What can Dad do now to avoid this tax? If it is unlikely that his daughter will accumulate more than her exemption amount during her lifetime, then one option to consider is for her to make a gift of the stock back to Dad (at least one year before her death), and then she can inherit the stock back herself at Dad’s death with a stepped-up basis. This is but one example of why readers should contact their estate planning attorneys to review their current situations.
Another possible effect of the new tax law lies with the common use of formulas in wills…and some new pitfalls thereof. I’ll cover this aspect in my next post.