It was expected—perhaps foolishly—that the American Taxpayer Relief Act of 2012 (the “ATRA”), signed into law on January 2, 2013, would end the fluctuating estate and gift tax exemptions by setting the unified exemption at $5 million per individual, indexed for inflation, and the maximum federal estate and gift tax rates at 40%. However, the estate and gift tax exemptions have remained a point of contention. The Obama administration has proposed lowering the exemption back to the pre-ATRA level of $3.5 million and has been threatening to curtail, or even eliminate, certain planning options, such as implementing a minimum 10-year term for Grantor Retained Annuity Trusts (GRATs).1 This trend has continued in the administration’s 2015 proposal, which includes eliminating certain capital gains benefits available at death.2
1. In addition to raising the capital gains tax rate, the administration’s proposal eliminates the “step-up” in basis for assets transferred at death.
2. Lifetime planning and gifting can offer significant tax reduction and deferral benefits.
3. It is important to take advantage of the planning techniques while they are available.
Stepped-Up Basis
“Basis” is essentially the owner’s cost for purposes of income or capital gains tax. For example, if an individual buys $1,000 of stock and sells it for $1,500, his basis in the stock is $1,000 and his taxable gain is $500. Thus, the higher an individual’s basis, the less income tax is owed.
When an asset is transferred at the owner’s death, the basis is “stepped up” to the date-of-death value, reducing the recipient’s income tax liability upon sale. On the other hand, when an asset is transferred by gift, the owner’s basis is “carried over” to the recipient, increasing the recipient’s income tax liability upon sale.
The administration considers the step-up in basis a “trust fund loophole” for the wealthy and has proposed that the loophole be closed by treating death as a taxable event. At death, the decedent’s basis would be subtracted from the asset’s date-of-death value and capital gains tax would be due on the difference. The proposal includes a $100,000 capital gains exclusion per individual.
Lifetime Planning
Planned giving continues to offer significant tax benefits for those with a taxable estate. Gifting assets that have appreciated or are expected to appreciate can not only reduce the owner’s taxable estate, but can also pass future appreciation forward and postpone the taxable event. Additionally, since tracking and maintaining the purchase price of long-term assets can be difficult, transferring such assets during the original owner’s lifetime can ease the burden of recordkeeping and estate administration. Of course, by gifting such assets to an irrevocable gift trust, the owner can realize these benefits and reduce the size of his or her taxable estate without surrendering complete control to the beneficiaries.3
In addition to appreciating assets such as stocks, business interests or real estate, life insurance can serve as a significant wealth transfer tool—even more so if the capital gains proposal becomes law. Since the death benefit proceeds of life insurance are income tax free, proper planning with life insurance will likely become an even more efficient method of passing wealth to the next generation.4
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1. Please see 10-Year Minimum GRATs Added to COBRA Legislation.
2. “A Simpler, Fairer Tax Code that Responsibly Invests in Middle Class Families,” White House, January 17, 2015.
3. Please see Estate Planning to Keep Your Children Motivated.
4. Please see Estate Planning With Life Insurance.