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The Planning Conundrum (Part 3)


Part 3 of a 3-part series


The pre-rollback exclusion amount follows this rule: use it or lose it. This creates a puzzle: if you use it (and give away assets) then you face issues like “will capital gains be higher than estate taxes?,” “can I trust my children with that much money now?” and “can I get by after giving away a large chunk of my assets?” You also face the possibility that Congress, at the last minute in late 2025 will decide the rollback is a bad idea and make the $12.92 million exclusion permanent before 2026 arrives. Then you’ll ask, “Did I waste my time, effort, and money?” The answer to the puzzle is not easy and will be different for each family. The issues must be carefully considered so the solution you deem appropriate can be applied. Work with your experienced Certified Elder Law Attorney.

Capital Gain Tax and Basis

Another issue you must consider is that value you gift to someone retains your tax basis, but value you let someone inherit gets a step-up in basis. Basis is how capital gain tax is calculated and imposed. Example:


A) You gift $20 million in stock to your daughter. You had paid $2 million for the stock originally. Her tax basis is the same $2 million as you. If she sells the stock immediately, she has $18 million of capital gain which is taxed at up to 20% (about $3.6 million tax).

B) You die with your $20 million in stock and leave it to your daughter. As an inheritance, her basis is adjusted up to the market value of the stock at the time of your death. Since you died owning the stock, estate tax is due on $20 million minus the exclusion ($12.92 million before the rollback, $6 million after the rollback). Pre-rollback estate tax is about $2.8 million. Post-rollback estate tax is about $5.6 million. She gets the balance. If she sells that balance of the stock immediately, she pays zero capital gain tax.

A possible solution: the Annual Gift Tax Exemption

As stated earlier, the annual gift tax exemption was $16,000 per recipient per year in 2022 and is increasing in 2023 to $17,000 per recipient per year. If you have three recipients, you can give each one of them $17,000 each year without paying tax on the transfer. If you are married, the two of you can each do this, for a total transfer of $34,000 per recipient per year. Most people are more likely to gift assets to their children or grandchildren, but the exemption applies to anyone: friends, neighbors, strangers. It does not apply to qualified charities, to whom you can give tax-free gifts in any amount (some or all of which may be tax deductible). Of course, non-charitable gifts are still not tax deductible but are free of gift tax if the value is within the exemption limit.


The more recipients you have, the larger the impact. If you have three children, you can reduce your estate by $102k each year without any reduction in your basic exclusion amount (which is $12.92 pre-rollback). If you have additional objects of your bounty (kids, grandkids, other family, other beneficiaries) you can do the same for each, increasing the amount you annually remove from your taxable estate using the annual gift tax exemption. For young recipients, you may funnel money into irrevocable trusts or into college 529 plans. This is a viable way to reduce the size of your estate so it will not exceed the exclusion amount when you die.

 

Paul Premack is a Certified Elder Law Attorney for Wills and Trusts, Probate, and Elder Law issues. He is licensed to practice law in Texas and Washington. To contact us, click here.


Column published on November 28, 2022.