Tax reform in 2017 increased the exemption against the federal estate tax from about $5,600,000 to about $11,200,000 for each individual ($22,400,000 in the case of a married couple) from now through 2025. This means that there are far fewer families with wealth subject to estate taxation.
In the current environment, with so many families below the estate tax thresholds, protecting assets from creditors, from the claims of a child’s divorcing spouse and from capital gains tax is a bigger concern than estate taxes. The current high exemption environment is scheduled to sunset in 2026, but in the meantime, many couples with non-taxable estates have outdated estate plans.
Capital gain subject to income tax is generally calculated by subtracting the basis of the asset from sale price of an asset. “Basis” is generally the owner’s investment in an asset. Upon an individual’s death, the general rule is that the beneficiary’s “basis” in the assets passing from the decedent (other than retirement accounts) is “stepped up” to the fair market value of the asset at the decedent’s date of death. The “step up” in basis can be a powerful planning tool.
For example, if Susan purchases a share of stock for $10 on January 1, 2000 and sells it for $100 on December 31, 2018, the taxable gain on that transaction will generally be the $90 difference.
If instead, Susan purchases a share of stock for $10 and passes away on December 31, 2018, leaving that stock to her son Joe, Joe’s basis in the stock is the $100 fair market value as of Susan’s date of death. If Joe later sells the stock for $100, there is no taxable gain on that transaction.
We are revising many clients’ estate plans that were drafted with the estate tax in mind to provide a “step up” in basis of some or all assets at the death of the first spouse, then another “step up” in basis at the death of the surviving spouse. This can provide significant income tax savings to the family but exposes the assets to estate taxation. As long as the estate tax thresholds remain high, this strategy will provide tax savings to many clients. This is a particularly powerful strategy for executives who own a concentrated position of company stock, owners of closely held businesses, and other investors.