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Why Basis Planning is the New Estate Planning

Posted on: February 25th, 2016
basis planning​Dramatic changes in income and estate taxes have occurred in recent years. Estate planning has, for many, taken on a new and very different focus. First, for all but the wealthiest 0.2 percent of the population, the federal estate tax no longer applies. North Carolina repealed the state estate tax in 2013, Florida in 2005, and Tennessee fully repealed theirs as of the first of this year. For everyone else, the tax objective of estate planning is to have assets included in appropriate estates (not just your estate and your spouse's, but potentially the estate of a family member) so that the assets can benefit from what is called in tax jargon a "step-up in tax basis."
 
In simple terms, an asset included in someone's estate will obtain an income tax basis (the amount on which capital gains and losses are calculated) of the fair market value on the date of death.
 
​​Creative planning can help you and your heirs avoid income taxes on future sales of assets. The tax benefits can be significant.

Why Basis Planning?
 
Many years ago when the federal estate tax exemption was under $1 million, most of our clients included Credit-Shelter Trusts in their estate plans. These trusts, also called Bypass Trusts, Family Trusts or Trust “B,” would receive the assets of the first spouse to die, up to the estate tax exemption amount. While the surviving spouse could tap into the funds during his or her life, when the surviving spouse died the remaining assets would not be included in his or her taxable estate. The savings in estate tax would have been as high as 55% of the trust assets.
 
The trade-off to the estate tax savings was that the appreciated assets did not get a step-up in basis at the surviving spouse's death. For example, if a parcel of real estate was worth $100,000 at the death of the first spouse to die, but appreciated to a value of $200,000 when the survivor died, when the property was sold by the children a $100,000 taxable gain occurred, resulting in at least $15,000 in federal tax. This was much less than the estate tax of $55,000 or so would have been, making the Credit-Shelter Trust plan practically a no-brainer.
 
However, under current law very few us need to worry about estate taxes. Along with income tax rates in general, capital gains rates have gone up, so proper planning now focuses on reducing capital gains tax.
 
In the example above, rather than having the property go into a Credit-Shelter Trust, it could be directed to a Marital (QTIP) Trust, or even outright to the surviving spouse. Then, at the survivor’s death, the $100,000 basis would be “stepped-up” to the current fair market value of $200,000, resulting in no capital gains tax to the children upon sale. The savings could be as high as 20% in federal tax and 5% or more in state tax.
 
This new planning environment means most people should review:
  • Your will/revocable trust and related planning. These documents might need to be revised to include provisions that take advantage of basis step-up.
  • Existing irrevocable trusts. These may have been formed to minimize estate tax, but now might result in costly income tax with no commensurate estate tax savings. Modification may be possible under current law.
  • Existing life insurance coverage and insurance trusts. Insurance will often remain a valuable planning tool, but for many it may be used differently and various types of coverage may be preferable.​​
Review documents with an estate planning attorney to update plans and take advantage of these new opportunities. 

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