Fewer than 1% of Americans are now subject to federal gift, estate and generation-skipping transfer tax because those taxes do not apply unless the value transferred during life and at death exceeds an “exclusion amount” of $5.45 million per individual ($10.9 million for a married couple), adjusted annually for cost of living. Most individuals and couples can shift their focus from estate tax avoidance to strategies to minimize income taxes on lifetime gifts and transfers at death. Key issues include income tax basis and fiduciary income tax reporting.
- The recipient of an asset given away during life takes over the donor’s basis in the asset for purposes of calculating capital gain on later sale, so a donor should select a high basis asset for any lifetime gift. At death, however, the cost basis in most assets (excluding certain assets like retirement plans or IRAs) is adjusted to the date of death value, and any built-in capital gain is avoided. A person who receives an asset from a decedent calculates gain on later sale based upon the date of death value of the asset. The executor needs to secure this information, and the recipient needs to retain it.
- For married couples, the rules can become more complicated. For example, if a married couple owns community property (in Arizona, Nevada and Texas), community assets receive a 100% basis adjustment at the death of the first spouse, and, again, at the death the second spouse if any of the formerly community property remains. If a married couple lives in a common law state (like Florida, Kentucky, Michigan, Ohio or Tennessee) and owns property as tenants by the entirety, only 50% of the value is adjusted at the first death, although a second adjustment becomes available for 100% of what remains at the second death.
- If a decedent directs transfers into continuing trusts for beneficiaries, the trustee needs to be alert to ways to minimize income taxes. Fiduciary income tax is assessed at the highest rate bracket after $12,400 of income, but appropriate distributions to beneficiaries can help avoid application of the highest rate.