The federal estate tax is no longer the biggest worry for people who want to avoid taxes when they leave their estate to their family. With the estate tax exemption at $5.45 million for single people (and $10.9 million for married couples with some relatively simple estate tax planning utilizing tax deferral and portability), the main taxes that will eat at the family legacy are the income tax and the capital gains tax.
The income tax is a factor when your wealth management clients leave their estates to their families because so many people these days have their IRA as their major financial asset. Whenever distributions come from an IRA, the recipient must include the distribution as part of their taxable income.
But the other big, hidden tax that families unknowingly incur when they pass their estate to their survivors is the capital gains tax. Your clients may need to do a complete "about face" with their estate legal plan in order to perhaps preserve the "double step-up in basis" (referred hereinafter as the "DSUIB")
Just a few years ago, the DSUIB was an after-thought. The focus was to keep the assets of the first spouse to die out of the estate of the surviving spouse. The focus was on reducing the size of the taxable estate of the surviving spouse. Now, at least for married couples that have an estate that does not exceed $10.9 million, the size of the taxable estate of the surviving spouse may be irrelevant. Today, many families will want to INCREASE the size of the taxable estate of the surviving spouse because all assets that are in the taxable estate of the surviving spouse get ANOTHER step-up in basis upon the death of the surviving spouse.
The traditional QTIP testamentary trust that many of your clients have in place will not permit their survivors to take advantage of the DSUIB.
Example. During Peter and Martha's lifetime, they acquired 10,000 shares of stock with a basis of $5 per share. When Peter died, the stock was valued at $30 per share. If Peter was domiciled in a community property state (like Louisiana or Texas or California), all of the stock would get a step-up in basis when Peter died. Under the traditional estate plan where Peter left his stock to a QTIP trust, Peter's 5,000 shares would not get another step-up in basis when Martha died. When Martha died, the stock was worth $75 per share. Since Peter and Martha's estate legal plan did not consider the DSUIB, their children incurred an extra $56,250 in capital gains tax when the children sold all of the stock after Martha's death, because Martha's taxable estate (for estate tax purposes) did not include Peter's half of the stock - this stock did not get another step-up when Martha died.
If your wealth management clients have a desire to reduce or eliminate the amount of tax that their heirs will have to pay, you may want to give me a call to discuss how an estate legal program can be set up to preserve their DSUIB. As you can see from the example above, a modest estate can save more than $50,000 in tax (keeping this amount in the family and away from the government) by structuring the right estate legal program.