The Finances of Estate Planning for Smaller Estates

Over the years, the estate planning game has changed for the majority of taxpayers.  Due to the increased exemptions, only 1,800 decedents will be required to pay an estate tax in 2019, but the need for planning continues.

One of the prime planning objectives will be to take advantage of the stepped-up basis at death to minimize income taxes on the ultimate sale of inherited assets.  Most taxpayers will be able to take advantage of the step-up in basis and the resultant income tax savings without paying a penny in federal estate taxes.  Taxpayers with a taxable estate of less $11.58 million or $23.16 million for married couples will owe no federal estate taxes in 2020.  This exemption is expected to sunset in 2025 and return to 2017 amounts indexed for inflation (approximately $6-7 million for a single taxpayer and $12-13 million for married couples).

Consider the following example to illustrate the impact of the stepped-up basis.  A taxpayer with securities of $5 million in value and a cost of $3 million, could potentially owe just under a half-million dollars in federal income taxes if the securities were sold during life.  If the taxpayer dies owning the securities, and their heirs sell the stocks right away for the same $5 million, they will owe zero income taxes.

If you are charitably inclined, and will not owe any estate tax, consider allowing your heirs to inherit cash or securities and request they contribute to a charity.  In this way, you pay no estate taxes, and your heirs could take the charitable deductions on their tax income return and save income taxes.  If the charity were to inherit the assets directly and is under the exemption amount, there would be no federal income tax or estate tax benefit.

Charitable Gifts

If you want to make a charitable gift, but don’t necessarily want to rely on your heirs to follow your request, you can also consider making a charity the beneficiary of your IRA.  Unlike an individual, the charity will not have to pay income tax on the IRA distribution, allowing more of your money to funnel to your heirs and the charity due to the income tax savings.

A popular recommendation is to consider gifting non-appreciated assets to reduce your estate while at the same time avoiding potential income taxes by utilizing the stepped-up basis on assets at death.  This is a good recommendation from an income tax perspective, particularly if you are looking to make gifts, but it will not necessarily yield as many estate tax benefits for a smaller estate as a larger estate.

Basic Exemption Amount

The basic exemption amount (BEA) applies to lifetime gifts as well as assets at death.  That is, currently, you can give away during life, or die with $11.58 million of assets today, without paying gift or estate tax.  However, when the current exemption amount sunsets, that amount will be significantly reduced.  If you give away less than the BEA in effect when you die, the gifting will not reduce your overall estate taxes.  If you have gifted away more than the BEA in effect at your death, you will have successfully avoided some portion of the estate taxes.

For example, if a taxpayer dies in a year when the BEA is $5 million and has given away $5 million in assets during life, they will have utilized all of the exemption available to them and any assets over the $5 million will not be sheltered by the exemption.  If a taxpayer gives away $8 million during life that was sheltered by the BEA and dies when the BEA is $5 million, the additional $3 million gifted during life will continue to be exempt.  Accordingly, by gifting more of the BEA during life, the taxpayer was able to shelter more assets from estate taxes. Given a 40% estate tax rate, the savings, in this case, could be as much as $1.2 million.

In addition to taxes, there are many items that should be considered when drafting an estate plan, not the least of which is preserving and protecting your assets and your heirs. If you need assistance implementing an estate plan, Klatzkin can help. For additional information, call us at 215-752-4242 or click here to contact us. We look forward to speaking with you soon.