Basis Step-Up
Currently all assets includable in a decedent’s gross estate receive an income tax basis equal to the value of the asset as of date of death. This is important because the capital gains tax is computed on the excess of any sale price over and above the income tax basis.
Because of a “step-up in basis,” substantial capital gains tax can be eliminated when inherited property is sold. This should always be kept in mind before selling appreciated assets during the client’s lifetime, which could result in capital gains tax; or gifting appreciated assets during lifetime, which results in the original tax basis carrying over to the recipient of the gift—who may then have to recognize a capital gain upon the sale of the gifted property.
Further, special treatment is given to community property under the federal income tax laws with regard to a step-up in basis. Community property receives a full basis adjustment of the value of the asset upon the death of the first spouse to die. In contrast, non-community property only receives a basis adjustment upon the death of the spouse who owns the property and jointly held property only receives a 50 percent basis step-up upon the death of the first spouse to die. Community property states include Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin, as well as Alaska, which is opt-in only.
Federal Generation-Skipping Transfer Tax Exemption
Transfers to future generations using multi-generational trusts or outright gifts can eliminate further estate tax on the estates of these future generations. However, in addition to the federal gift and estate taxes, there is a federal generation-skipping transfer (GST) tax that must be taken into consideration.
The Internal Revenue Code does allow for a GST tax exemption, currently in the amount of $5.45 million, as adjusted for inflation, but the federal GST tax rate above this exemption is a flat 40 percent. Therefore, planning for the best use of the GST tax exemption often involves the use of lifetime multi-generational trust arrangements that could be funded either by making gifts during a grantor’s lifetime and/or by transfers upon the deaths of the grantor and his or her surviving spouse. When the GST tax exemption is properly utilized, assets can appreciate in value and transfer from generation to generation without the incurrence of any additional transfer taxes through the use of a multi-generational dynasty trust.
The federal GST tax exemption is not portable. A surviving spouse cannot use the GST tax exemption of his or her deceased spouse as one can do for the federal estate tax exemption.
There are many other sophisticated estate-planning techniques that can be quite beneficial under the appropriate circumstances, but the failure to take advantage of the exemptions, exclusions and deductions sanctioned by their inclusion in the Internal Revenue Code are definitely missed opportunities and should not be overlooked. With proper planning, many of these opportunities could be available and easily used to benefit your clients’ families and other beneficiaries for years to come.
Debra Smietanski is a special counsel and estate planning attorney with Foley & Lardner LLP. She focuses her practice on complex estate-planning techniques for high-net-worth individuals, and is board certified by The Florida Bar in Wills, Trusts and Estates. She can be reached at [email protected].