Face it. Most families simply won't have to worry a lick about the federal estate tax. That's because about 99% of unmarried people don't have an estate that exceeds $5.45 million. And more than 99% of married couples don't have a combined estate of $10.9 million. So, for most families, no worries about trying to avoid the 40% federal estate tax.
But almost every family who engages in estate planning has assets that have appreciated in value. That means there is the potential for capital gains tax at both the federal and state level when those appreciated assets are sold.
Example: Let's say Dad bought stock in ABC Co. for $5 per share over the years. Now, that Dad is 76 years old, ABC Co. stock sells for $60 per share. That means that there is $55 of gain in each share of stock that Dad owns. If Dad sells the stock during his lifetime, he'll get hard with a capital gains tax.
Now let's say that Dad wants to beat the system so he decides to put that stock in his children's names before he goes into a nursing home (to avoid nursing home poverty) and before he dies (to avoid probate and to avoid death tax). So, he puts the stock in his kids' names. Voila - Dad thinks he beat the system. But after the transaction is complete, the stock goes up even more (let's say to $100 per share) and the kids decide to cash in and sell the stock. What no one realizes is that when Dad transferred the stock during his lifetime to the kids, the basis of the stock "carried over" to the kids, so when the kids sell the stock, they will have to pay capital gains on everything they receive in excess of the $5 per share. So, $95 per share will be subject to a 20BUT +% capital gains tax at the federal and state level.
Perhaps if Dad would have put the stock into the right kind of Grantor Trust, he would have removed the stock from his name for probate and nursing home purposes, BUT HE WOULD HAVE PRESERVED THE STEP-UP IN BASIS AT THIS DEATH. So, when Dad dies later when the stock is worth $100 per share, and then the kids sell the stock for $100 per share, the total capital gains tax bill for the sale will be $0 or zilch. Even though Dad kept the stock in his taxable estate by transferring it to a Grantor Trust, there will be no estate tax due to Dad's estate being valued at less than $5.45 million.
Many a "Do-It-Yourself" estate planner have mistakenly believed that they beat the government or beat Uncle Sam by putting stock or other appreciated assets in their kids' names while they are alive. But what they don't know is that Uncle Sam is laughing at them from a distance knowing that when the asset is later sold, Uncle Sam will collect a bundle because the children, unfortunately, receive a "carry-over" basis in the stock, as opposed to a "stepped-up" basis in the stock.