Focusing on Income Tax for the 99.85%

black-29972_150.pngToday, the federal estate tax exemption is $5.34 million, and this number is indexed to inflation, so will rise over time. I was recently at the Stanford University and the Silicon Valley Community Foundation’s annual Conference on Charitable Giving, and heard that the White House’s Office of Management and Budget has estimated that this means that only .15% of estates will be subject to the estate tax in the future.

In less wonky terms, this means that less than 1 out of every 100 American households will ever have to file an estate tax return. It also means that more than 99% of Americans don’t need a charitable deduction at death, since they’ll have no estate taxes to reduce by that deduction.

As a result of the high exemption level, the focus of estate planning, for many families, has shifted from planning as a way to reduce the estate tax that may be due at death to other priorities. It is still important, of course, to use planning as a way to manage assets for minors, to distribute your assets at death and to avoid probate. 

But estate planning now can be used to do planning to reduce the income taxes that may be due after a death, as well as serve as an opportunity to take a look at using the charitable deduction to reduce income taxes during life, when it can be helpful, instead of waiting to make charitable gifts at death, when the estate tax deduction won’t do the estate any good (from a strictly tax perspective).

Here’s a quick overview of some of the new considerations:

Making charitable gifts during life. A charitable donation now can reduce your estate, while providing you with an immediate tax deduction.

Making charitable gifts of appreciated assets.  If you own highly appreciated assets that will result in expensive capital gains when sold, consider using these assets to create a charitable remainder trust or to purchase a charitable gift annuity.  Either approach can provide you with immediate tax deductions (which can be carried forward over a period of years) as well as an income stream at a higher rate of return than you can easily find in today’s low interest environment (though this varies and depends upon your age).  The charity can sell those appreciated assets without having to pay the capital gains and reinvest the proceeds in a more diversified portfolio.

Revising your estate plan to put assets likely to appreciate into the taxable estate of the surviving spouse. While counter-intuitive in the old days of low estate tax exemptions, today’s exemptions are so high that keeping assets likely to appreciate in the estate of the survivor won’t trigger an estate tax at their death, but will result in lower capital gains to be paid by the children, when they sell that asset after the second death. This works because assets held in the survivor’s estate will receive a step up in basis after that person’s death, reducing the capital gains taxes due to the appreciation that occurs after their death. Assets held in trust for the survivor’s life, but excluded from their taxable estate at death (a traditional estate plan that many of our clients have and that works well for many), in contrast do not receive a step up at the second death. Of course, this approach leaves you vulnerable if Congress changes the estate tax exemptions, but the current law does not have a built-in expiration date.

Remembering to take advantage of the portability provisions of the current tax law.  Today, the surviving spouse can file an estate tax return, even if it’s not otherwise required, to request the use of the deceased spouse’s unused estate tax exemption. As a result, a couple can now pass up to $10.68 million dollars to their beneficiaries without having to pay any estate tax.  This can be used in conjunction with the planning that I’ve just described above–leaving assets in the survivor’s taxable estate. Like many things tax-related, of course, this is not simple, as an estate tax return is a project to put together and if a spouse remarries, they’ll lose the exemption of that first spouse.

Encouraging children to make charitable gifts in the memory of their parents from their own assets (not the ones that they have inherited).  If you really want charitable gifts to be made after your death, consider asking your children to make gifts in your memory. Explain to them that they should make these gifts with their own assets (especially those with a low basis), rather than with the assets that they will inherit from you (which will have a stepped up basis to current value if they come from the survivor’s estate). Doing so will give your children an immediate income tax benefit, will reduce the capital gains due on sale of appreciated assets, and will reinforce the importance that you placed on charitable giving.