Tag: estate tax

Man Evaluating Property

Proposed Treasury Regulations Aim to Reduce Valuation Discounts on Family Gifts

Significant Changes for Family Gifts

On August 4, the Treasury Department issued proposed regulations under Internal Revenue Code Section 2704 that, if enacted, would significantly limit the applicability of valuation discounts to certain intra-family transfers.

Gift and Estate Tax Implications

In many cases, this limitation would prevent individuals from discounting the value of gifts of real property or business interests made to the individuals’ family members, causing the individual to use more of his or her gift tax exemption amount when making lifetime gifts.

Likewise, the proposed regulations would significantly limit the use of valuation discounts when calculating the size of the gross estate of a decedent, thereby increasing the value of the estate for estate tax purposes and the amount of estate tax payable.

Public Hearing in December

The public hearing on the proposed regulations will not be held until December 1, 2016, and thus the regulations will not become final this year.  Although we believe it is unlikely that the regulations will become final in their present form, we do expect that regulations limiting the availability of valuation discounts for certain intra-family transfers will become final – probably in 2017.

Explore Gifts in 2016 vs. 2017

For that reason, if you are considering making a gift of an interest in real property or a business, we suggest that you at least explore the option of doing so in 2016, rather than waiting until 2017 when the tax results may be less favorable to you.

Estate Tax Form Pencil

A Look at History:  The Estate Tax Exemption Really Has Increased

In a post earlier this year, we discussed that Americans can now transfer more than $5 million dollars in assets through the estate tax system without incurring a tax, while at the same time permitting their beneficiaries to receive those assets with a new and usually higher “stepped-up” basis.

Addressing the concept gave rise to the question:  Given inflation over the years, is the estate tax exemption really higher than it has been historically?  In order to answer that, we created a table showing the estate tax exemption over time, comparing it to the current buying power of the exemption amount in 2015 dollars.

While the comparisons are not perfect because the tax laws have changed over the years, the chart illustrates that the current exemptions are, indeed, historically high.

Throughout most of the twentieth century, the buying power of the exemption amount hovered at around $500,000 measured in 2015 dollars. The exemption’s 2015 equivalent started creeping up in 1990, but did not reach the $5,000,000 range until 2011. (The basic outline of the gift and estate tax laws has been consistent since the early 1980s.)

As noted in the earlier post, the exemption amount has been historically-high for several years.  There are no signs that it will be reduced in the near future.  It is clearly time to consider free basis when making estate planning decisions.

Tax Year                               Estate Tax Exemption                          2015 Equivalent

1920                                          $50,000                                                     $585,805

1930                                          $100,000                                                  $1,406,000

1940                                          $40,000                                                     $562,000

1950                                          $60,000                                                     $584,000

1960                                          $60,000                                                     $476,000

1970                                          $60,000                                                     $363,000

1980                                          $161,000                                                  $459,000

1990                                          $600,000                                                $1,078,000

2000                                          $675,000                                                  $920,000

2001                                          $675,000                                                  $895,000

2002                                          $1,000,000                                             $1,305,000

2003                                          $1,000,000                                             $1,276,000

2004                                          $1,500,000                                             $1,864,000

2005                                          $1,500,000                                             $1,803,000

2006                                          $2,000,000                                             $2,329,000

2007                                          $2,000,000                                             $2,264,000

2008                                          $2,000,000                                             $2,180,000

2009                                          $3,500,000                                             $3,829,000

2010                                          Unlimited

2011                                          $5,000,000                                             $5,217,000

2012                                          $5,120,000                                             $5,234,000

2013                                          $5,250,000                                             $5,290,000

2014                                          $5,340,000                                             $5,295,000

2015                                          $5,430,000                                             $5,430,000

 

Estate Tax Image

There is a Free Lunch – Rethinking Your Relationship With the Estate Tax System

Americans have been trained to fear the US Estate Tax system, sometimes called the death tax system.

However, now that a single person can transfer more than $5 million through the estate tax system without paying a tax, the time has come for us to change our way of thinking.  We need to change our thinking because the estate tax system includes a hidden gift that is now extremely valuable.

The gift is this:  Assets that pass through the estate tax system receive a new basis, which is the value of the asset on the date of death.  Given the number of assets that have increased in value over the course of the past 40-50 years, the new basis at death is frequently an increased “stepped up” basis.

To begin at the beginning, the tax basis of an asset is generally the price that a taxpayer paid for the asset.  The tax basis is important, because it is the measuring point for determining a taxpayer’s gain or loss on disposition of the asset.  So, if a taxpayer paid $1.00 for a share of stock, then sells it for $10.00, the taxpayer’s gain is $9.00, and the taxpayer has to report that gain and pay a tax on it.

The lesson is: The higher an asset’s basis, the better.

The problem is that basis increases generally are not free.  For example, if a person owns a rental property, he or she can increase basis by spending money on the property with the addition of a capital improvement.  The basis adjustment is the direct result of spending money.

Historically, the basis adjustment that is available through the estate tax system – like other basis adjustments – came with a price tag.  The property was subject to estate tax and it emerged from a painful taxation system with a new basis because it had generated a tax payable to the IRS.

Now, though the estate tax exemption is so high that people can use the estate tax system to acquire something that was inconceivable not so long ago: free basis.

The logic to free basis:

  1. The price of the basis adjustment at death has been the need to expose the asset to the estate tax system and the consequent need to pay an estate tax at high rates.
  2. Now, though, the estate tax exemption is so high that many people can expose their entire fortunes to the estate tax system without paying any tax, and many can do this without even filing an estate tax return.
  3. Since Congress did not change the basis adjustment rules when it changed the exemption amounts, the assets that go through the estate tax system painlessly (and perhaps without even filing a return) still receive a basis increase at no cost, which equals free basis.

The key underlying lesson to learn from the current situation is that – even if you cannot look at the US Estate Tax system as a friend – you can look at the system as a neighbor you need to learn to live with.

A few ideas to help you take advantage of free basis:

  1. Historically, parents have given assets that were likely to appreciate to children, so that the appreciation would not be exposed to the estate tax system at the parent’s death. However, when the gift was made, the parent’s basis would transfer to the child, and would not be stepped-up at the parent’s death.  This made sense when the estate tax system imposed a price.  Now that the system does not impose a price for most people, it makes sense for the parent to hold the asset until death so that it can be transferred to the child with a free basis increase.
  1. You probably have a natural aversion to taking money from your IRA, because you pay income tax on your withdrawals. However, if your aversion to taking money from your IRA were to cause you to sell an asset to pay tax at the capital gains rate, you might reconsider.  The assets in the IRA will not get a basis increase when you die.  The capital asset outside the IRA will get a basis increase.  Your situation might be improved by taking money from the IRA and leaving the capital asset on hand so that it can be eligible for free basis.
  1. Think twice before making annual exclusion gifts with anything but cash.
  1. Don’t get involved with family limited partnerships and fractional interest discounting unless you are rich enough to really need them.
  1. Recognize that a traditional A/B Trust may result in the loss of a stepped-up basis at the death of the second spouse. While an A/B Trust can still make good sense for family reasons (especially dealing with a blended family), you should be sure that the trust has been modified to provide a method for obtaining an increased basis. The attorneys in our firm are adept at accomplishing this without disrupting family dynamics.