When we think of taxes, it is usually in the context of sales or income tax. With a new administration poised to shift direction in prioritizing social services and expanded health care, estate planners may need to take a new look at the effect that changes in capital gains and estate tax will have on your portfolio.
The new tax plans and how they change income taxes on death
To realize a proposed $4 trillion tax plan, the more obvious taxes on capital gains and qualified dividends at income tax rates of 39.6% or higher will likely happen again. The big tax increase that is likely to hit estates with the incoming administration, however, is by changing how income will be taxed on death.
There will likely be a repeal of the present step-up in basis for inherited assets. Right now, the law increases the tax basis for inherited assets to full fair market value upon death, which allows the passing on of appreciated assets at current market value. When that inherited asset is sold, capital gains will apply only to an increase in value from its adjusted value, not its original value.
As this would apply to an inherited business, a stepped-up basis on death for income will in effect tax an asset’s unrealized appreciation to transfer. That means that if the children who inherited stock in the family business hoped to sell the business, they will be taxed on the unrealized gain at death, whether or not they decide to sell.
Taking advantage of current law
The Tax Cuts and Jobs Act of 2017 increased the estate tax inclusion from $5,450,000 to $11,400,000, which is doubled for married couples at $22,800,000. Because the tax exemption is portable, it can be transferred to a spouse, so that the spouse can pass property on to heirs debt-free. For example, if one spouse’s estate is valued at $5 million, they can give the remaining exemption of $6.4 million to their spouse, who can then pass it on to heirs.
Although current exemptions have a sunset clause in 2026, it still gives people time to plan ahead. One tax-avoidance mechanism is to use some of their exemptions to make tax-free lifetime gifts. Assets transferred to a dynasty trust will avoid gift and estate taxes altogether.
Because exemption taxes change every year, it is best to plan so that your property and assets are protected. It is important if you live in California to examine the tax implications of your estate plan with experienced legal counsel in the San Diego area, and make necessary changes sooner rather than later.