The federal estate tax is no longer the biggest concern for many people going through the estate planning process. However, this was not always the case. In 2004, any estate worth more than $1.5 million, or whose estate owner made gifts above that limit while alive, were subject to federal tax at top rates of almost 50%. There was extreme uncertainty as the federal tax levels bounced around from year to year and even disappeared entirely in 2010, which made effective planning exceedingly difficult.
Finally, last year Congress set up a new estate and gift tax rate, topped at 40%, and raised the exemption level to $5.34 million per person. Each year that number is adjusted for inflation and the level is expected to be set at $5.43 million per person next year.
New Tax Saving Opportunities
Many people are completely unaware of the new rules regarding estate planning, especially since some advice is completely contradictory to what has been suggested in the past. For example, in the past avoiding the estate tax often meant sacrificing efforts to minimize long-term capital gains taxes, which had a much-lower top rate of 15%. However, now many people who will not owe estate tax can reap substantial tax savings on capital gains by choosing which assets to hold within their estate until death.
Reviewing Estate Plans for More Savings
People that are covered by the new federal estate tax exemption should review their plans and see if there is more room for tax savings. Here are some important factors to consider when reviewing your estate plan:
Reset capital gains:
The federal code allows for a “step-up” in the value that cancels the long-term capital gains tax on assets that a person holds until death. The step-up automatically raises the owner’s cost basis for such assets to its full market value as of the date of death, negating the taxes on the appreciated value of the asset.
This means that if the owner holds the same asset until death, the capital gains tax vanishes. The asset will be included in the estate plan at full market value, where the federal exemption level could shelter it from federal estate tax as well, in addition to skipping capital-gains tax of up to 23.8% on any appreciation.
Using the right assets:
To meet cash needs in retirement, it may make sense to take out a loan rather than selling appreciated investments in taxable accounts, especially with the current interest rates so low.
Another possible strategy is to state making withdrawals from traditional individual retirement accounts or other retirement plans. Because such assets are in tax-deferred accounts, they don’t get a step-up in basis like other assets that you should keep.
Up until Congress created a provision known as “portability” in 2011, spouses often needed trusts to provide their estates with the full value of two federal estate-tax exemptions. However, now a surviving spouse can claim the unused portion of a partner’s exemption as long as the survivor files Form 706 with the Internal Revenue Service within nine months of their spouse’s death.
However, some couples can still benefit from the use of trusts in their estate plan. Many couples in states with death taxes can benefit from the use of a trust, and trusts can be crucial for married couples in which one spouse is a U.S. citizen and the other is not. Some estate planning attorneys are using a tool called an “estate trust.” It provides a double step-up on a highly appreciated asset to a married couple after the first spouse dies.