TaxProf Blog

Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Wednesday, March 7, 2018

The New Tax Law Shifts The Focus Of Estate Planning To The Income Tax

Daily Business Review, 2017 Tax Act Changes the Focus of Estate Planning to Saving Income Tax:

Traditionally, estate planning to maximize what passes to the next generation after taxes meant planning to reduce the federal estate tax. This was accomplished by reducing the size of a person’s estate at death through a variety of planning techniques. However, an estate is subject to estate tax only to the extent the estate exceeds the estate tax exemption. Over the years Congress has been increasing the estate tax exemption. For the years 2011 through 2017, the exemption was increased to $5 million adjusted for inflation, which equated to an exemption of approximately $5.5 million in 2017 after the inflation adjustment. The 2017 Tax Cuts and Jobs Act temporarily doubles the exemption for individuals dying in 2018 through 2025. In 2026 the exemption will revert to $5 million adjusted for inflation. As a result, in 2018 the exemption will be approximately $11 million after the inflation adjustment. In 2026, when the law reverts to the prior rules, the exemption will be $5 million adjusted for inflation, which will probably result in an exemption in excess of $6 million. ...

The reason income tax planning is a factor in estate planning is because Congress has retained the stepped-up basis at death rule.

The stepped-up basis rule provides that upon a person’s death, the cost basis in the deceased’s property for purposes of determining gain or loss upon sale of the property, becomes the fair market value of the property on the date of the decedent’s death. However, if the person gifts the property prior to his death, the cost basis of the recipient of the gift is the cost basis of the donor of the gift, which carries over to the recipient. For example, if an individual purchases an asset for $1,000 and dies holding the asset when it is worth $50,000, his heirs can sell the asset for $50,000 without incurring a taxable gain. However, had the person gifted the property prior to his death, and the recipient of the gift then sold the asset for $50,000, the recipient of the gift would incur a taxable gain of $49,000 because he would have taken the property with the donor’s cost basis of $1,000 and sold it for $50,000.

In the case of an estate that is not subject to estate tax, which is now a large majority of the estates, giving away appreciated property prior to death results in no estate tax savings because there is no estate tax due in any case, and creates taxable income for the heirs when they sell the property. In such cases the focus will be on planning in order to take advantage of the stepped-up basis at death. To the extent parents want to help their children by making gifts to them, there will be an emphasis on making gifts with high basis assets.

In larger estates the donor will want to use the temporarily doubled exemption during the years 2018 through 2025 before it drops back down to the pre-2018 level. Since the exemption can also be used to make gifts during lifetime, which reduces the exemption available at death to the extent used during life, the donor will want to make gifts, but with gifts there is a carry-over basis rather than a stepped-up basis. In such cases there will be plans to make gifts, and also obtain a stepped-up basis. One example of such a plan might be to make a gift and give an elderly relative with a modest estate a general power of appointment over the gifted property, which will cause the property to be included in the elderly relative’s estate at his or her death and stepped-up to the fair market value at the relative’s death. This would allow the donor to use the temporarily increased exemption through a gift at a time that the increased exemption is still available, and at the same time obtain a stepped-up basis.

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