Until recently, estate planning strategies typically focused on minimizing federal gift and estate taxes, such as by giving away assets during life to reduce the taxable estate. Today, however, the focus has moved toward income taxes, making the coordination of income tax planning and estate planning more important.
Why the change?
Since 2001, the federal exemption has grown from $675,000 to $5.45 million, meaning that fewer people have to worry about gift and estate tax liability. In addition, the top gift and estate tax rate has decreased from 55% to 40%, while the top individual income tax rate has increased to 39.6% — nearly as high as the top gift and estate tax rate.
The heightened importance of income taxes means that holding assets until death may be advantageous. If you give away an appreciated asset, the recipient takes over your tax basis in the asset, triggering capital gains tax should he or she turn around and sell it.
When an appreciated asset is inherited, on the other hand, the recipient’s basis is “stepped up” to the asset’s fair market value on the date of death, erasing the built-in capital gain. So retaining appreciating assets until death can save significant income tax.
Year end strategy
It is, however, possible to transfer appreciated assets now without your family taking a capital gains tax hit. Such a strategy can be beneficial if you have appreciated assets you’ve held more than one year that you’d like to sell, but you’re concerned about the impact on your 2016 tax bill.
You just need to have family members who are in the 10% or 15% regular income tax bracket and thus eligible for the 0% long-term capital gains rate. Then you can transfer the appreciated assets to them and they can sell the assets tax-free (to the extent the gains don’t push them into a higher bracket).
The transfer won’t create gift tax liability, either, as long as you can apply your $14,000 per year per recipient gift tax annual exclusion or a portion of your lifetime exemption. But before transferring the assets, make sure the recipient won’t be subject to the “kiddie” tax.
Of course, depending on the outcome of the November elections, gift and estate taxes could again surpass income taxes in estate planning importance for some families. If you have questions about coordinating your income tax planning with your estate plan, please contact us.