With a significant increase in the estate tax exemption amount, it is worth reviewing some of the tax aspects of immediate pre-mortem planning. While estate taxes are still a concern for some clients, for most clients, the main issue is the basis of the estate’s assets, as it has been for many years. Tax planning as part of estate planning is basis planning. For many, it is all about the basis.
To begin, do not forget to advise the client/client’s fiduciaries about non-tax related planning. Make sure assets are properly titled and health care directives are in place, and even advise the fiduciaries (often family members) how to properly sign as power of attorney so as to minimize personal liability, etc.
But what about tax planning?
DEATH BED GIFTS
Appreciated Assets: Clients love to avoid probate; however, if an appreciated asset is gifted immediately prior to death, the asset will not receive the basis step-up at death under Internal Revenue Code §1014. The income tax consequences to the beneficiary can be significant.
Assume the client purchased stock for $2. At the time of death, the stock was worth $10. A beneficiary received this stock as a gift prior to death and the stock is later sold by the beneficiary for $12. The taxable gain to the beneficiary is $10 ($12 – $2). The beneficiary receives a carryover basis only. If the same beneficiary receives the shares after the client’s death, the basis becomes the fair market value at death. The gain on the stock is $2 ($12 – $10 fair market value at death).
Depreciated Assets: What is often forgotten about the basis step-up at death rule is that it works in the other direction too. The rule is really a step to fair market value at death. So, for example, if the stock was purchased for $10, is worth $2 at time of death, and is later sold by the beneficiary for $6, there is a gain of $4 ($6 – $2) not a $4 loss ($10 – $6). So, if otherwise appropriate, sell securities in a loss position prior to death with the hope that the client can use the loss on his or her (likely) final income tax return.
Practice Tip: Remember that not all clients who are about to die, actually die (at least not for a while). A death bed gift not only may have adverse tax consequences, it can also interfere with Medicaid and Veterans Administration benefits.
WHAT IF THERE IS POTENTIAL FOR AN ESTATE TAX?
Consider making completed gifts of the annual exclusion amount under Internal Revenue Code §2503(b) as well as direct gifts for tuition and medical expenses IRC §2503(e). These gifts do not count against the lifetime exemption amount.
While it was not uncommon to see gifts that resulted in a gift tax when the exemption amount was much lower, it is less common to see that now. In any event, gifts made immediately pre-mortem, even with a gift tax due, are not likely to have a significant tax benefit if the client dies shortly after the gift is made. With that said, if the client lives, and the asset subsequently appreciates, there could be an estate tax savings because the appreciation is no longer in the client’s estate. Remember, however, that typical elder law clients will not have a taxable estate.
Practice Tip: Watch assets, such as real estate, that may be subject to another state’s death tax. In addition, some states have a gift tax, or may include gifts in the death tax calculation, if made within a certain time period before death.
Practice Tip: Care is also warranted if there is a risk your client may be deemed a resident of another state, particularly one with a death tax.
Reminder: Gift tax is paid by the person who made the gift. In some cases, particularly
with larger estates, having a gift tax paid pre-death can reduce the estate tax.
Note: With the higher estate tax exemption amount, this article is not addressing discount planning, which has always been a challenge immediately pre-mortem.
CHANGE OF RESIDENCY
The client’s family sometimes will bring the client back “up north” for their care. Often that up north state has a death tax and/or an income tax. In many cases, it is advantageous for the client to keep residency in Florida, if possible. If not possible, clearly change the client’s residency and update (or have updated) the client’s estate planning documents.
Practice Tip: As with most Florida residency planning, try to continue to focus the client’s life in Florida. In addition, consider obtaining (and updating) physicians’ written orders/care plans addressing why the client needs to be “up north” for care.
Traditionally, if there was charitable intent, immediately pre-mortem charitable gifts would not only reduce the estate’s taxable estate (which it would also do post-death) but also provide an income tax deduction. With estate taxes less of an issue, where can the charitable deduction be used most effectively? Will the charitable deduction help reduce the client’s income tax or would it be more income tax effective for a beneficiary to make the charitable gift? Of course, the beneficiary will need to be trusted to make the charitable gift in the client’s honor.
Practice Tip: Similarly, it is important to consider whether the post-death donation of tangible personal property (such as the furniture no one wants) should be made by the estate or instead by a beneficiary who then makes the donation and receives the income tax deduction.
Does the client have carryforward losses and suspended/passive losses? If so, consider using them (or have the surviving spouse consider using them in the year of death with a joint income tax return). If not used, they may be lost.
Practice Tip: If the beneficiaries plan to cash out a retirement plan promptly after the client’s death (rather than stretch the payout), consider cashing out some or the entire plan pre-death. In considering this approach, take into account the client’s and beneficiaries’ tax brackets and any of the client’s other deductions, carryforward losses, etc. These may offset the income if taken by the client.
Decide if the minimum distribution (or more than the minimum distribution) should be taken.
Practice Tip: If a minimum distribution is required and has not already been taken pre-death, make sure it is timely taken post-death.
GRANTOR TRUST TRANSACTIONS, CREDIT SHELTER TRUSTS, AND BASIS
Many clients set up irrevocable trusts when the estate tax exemption was much lower. Many of these trusts are taxed as grantor trusts with the income tax consequences passing through to the grantor client. See if the trust holds appreciated securities. If so, consider having the client purchase, for fair market value, the appreciated asset from the trust. Per Revenue Ruling 85-13, this transaction is not taxable to the grantor client (it is deemed to be a transaction by the client with the client). However, at the client’s death, the swapped asset should receive a basis step-up. Similarly, planning should be considered with credit shelter trusts created after the death of the first spouse to die. In some cases, it may even be advisable to shut down the shelter trust with the assets going to a surviving spouse. These assets may then receive a basis step-up at the surviving spouse’s death.
GIFT FROM BENEFICIARY
What if the spouse or other beneficiary has appreciated assets? Consider gifting these assets to the client (again, assuming the exemption amount is so high that there are no gift tax issues to the party making the gift). At death, the gifted property can go back to the beneficiary who gifted the property to the client – and do so at the stepped-up fair market value at death. Sounds too good to be true? Congress thought so too. Section 1014(e) does not allow the basis step-up if the death is within one year of the gift from the beneficiary, and with the gifted asset going back to the original gifting beneficiary.
Practice Tip: What is the tax down-side of trying? None really. If the client lives more than a year, the plan worked. If not, other than the gift itself, there is no harm.
Practice Tip: If the client is really not expected to live a full year, is the gifting beneficiary willing not to be the ultimate beneficiary? For example, is the client’s spouse willing to gift appreciated securities to the client and at the client’s death, have these assets go to children? This can work even if the death is sooner than a year from the original gift.
Trap: Make sure there are no strings or prearrangements with gift-back arrangements, as the Service can try to reverse the gift.
Article written by Michael A. Lampert and published by The Elder Law Advocate, Vol. XXVI, No. 2 (Spring 2019)