How To Make Sure Your Family Benefits From The Often-Overlooked "Double Step-Up in Basis"

"I want to set up my estate plan so my heirs must pay loads and loads of taxes to the state and federal government when I die," said no one - ever.

There's been an evolution in estate planning when it comes to avoiding taxes, and here is what it has looked like.

  • The 90's. Back in the 1990's, virtually all techniques to avoid tax when someone died centered around avoiding the federal estate tax. When someone died, the survivors would owe the federal government 55% of the value of everything that exceeded $600,000 in value. Many families took advantage of $10,000 present interest annual gifting. QTIP trusts were the way to go, along with family limited partnerships to slash the value of estates. Lots of life insurance was placed in irrevocable life insurance trusts.
  • 2000's. The estate tax exemption increased. Fewer families were subject to estate tax. The shift in estate planning started from attempting to avoid estate tax to attempting to avoid losing assets to the nursing home. During the year 2010, there was no estate tax and several wealth people died and completely avoided estate tax. Some individuals started accumulating large IRAs so there was lots of talk about minimizing and deferring income tax from retirement plans for as long as possible.
  • 2010's. Absent one year when the estate planning community told all wealthy couples to give away $10 million to their kids in one shot because the estate tax exemption was going to be reduced to $1 million (but that never happened), there has been little estate tax avoidance planning going on out there in the real world. With an estate tax exemption of $5.49 million (per spouse), and with new portability rules allowing married couples to avoid tax on roughly $11 million (if they take advantage of the portability rules) very few families will face estate tax.

But with land values increasing, businesses increasing in value, and a rising stock market, many families will unknowingly get walloped with state and federal capital gains tax - even if they worked with an attorney to develop a plan - because virtually everyone is ignoring the estate planning aspects of the capital gains tax.

Most planners and even most of the public are familiar with the capital gains step up in basis that heirs get when they inherit appreciated property. But few people and even fewer attorneys seem to be aware that heirs can benefit from the double step-up in basis, but the old-school estate planning documents won't allow it.

Example. Dad inherited stock during his lifetime. Dad and Mom decide to keep the stock. Let's say the stock was worth $10 per share when Dad inherited it. When Dad dies, the stock is worth $30 per share. Great, the stock gets a step up in basis to $30 when Dad dies. But Mom decides to keep the stock - she doesn't sell it. Mom lives for 15 more years and when Mom dies, the stock is worth $150 per share. After Mom dies, the kids decide to cash in and sell the stock for $150 per share. But guess what? Because Dad's estate plan was set up under the old-school estate tax rules, the stock does not get stepped up again when Mom dies. So the kids get hammered with a roughly 25% federal and state capital gains tax on everything they get in excess of $30 per share. Had Dad's and Mom's estate planning legal program would have been set up correctly, not only would there be no estate tax, but there would be no capital gains tax when the kids sell the stock because the basis of the stock would have been Stepped Up again when Mom died.

When you hear an attorney tell you, "Don't worry about tax because your estate is under $5 million," you may need to keep worrying. Failing to address the potential for capital gains tax that children must pay upon the sale of assets after both spouses die could cost the family many, many tax dollars. The "step-up" may not be what you need. You may want to make sure that your heirs get the "double step-up." Sure, it can be complicated to the lay person when we discuss the legal techniques and strategies necessary, but the key is to realize that typical, old-school estate planning documents that are set up to avoid estate tax are not likely to allow your family to benefit from the double step-up in basis.

If you want to have a solid program in place that protects your family from all types of state and federal taxes, give us a call at 225-329-2450 to start a conversation and determine whether you and our family can benefit from this type of tax-avoidance program.