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Estate Planning and Income Tax: Have a Plan

As of 2022, the current estate tax exemption is $12.06 million, allowing many to disregard concerns with federal estate tax. Compared to a decade ago, when planning was focused on how to limit the amount of federal estate tax possible, taxpayers are now able to move their attention to effectively planning to save their heirs’ income taxes.

It’s important to note, however, that this current large exemption amount is set to sunset at the end of 2025, to be reduced to $5 million starting in 2026. Also, keep in mind that Congress could institute a new amount or extend the high exemption amount to be later than 2025.

Here are some strategies to consider in order to benefit from the current large exemption amount

Gifts that use the annual exclusion

One way to save estate tax is by transferring assets during life to remove the asset and protentional appreciation in value from the donor’s estate. Any transferred assets and post-transfer assets with appreciation in value that would have been generated by those assets are excluded from annual exclusion.

Since the estate exemption is currently so large, estate tax savings may not be an issue. Additionally, initiating a transfer of appreciated property could result in the recipient incurring a potential income tax cost due to the recipient receiving the donor’s basis upon transfer. This could result in the recipient having to face a capital gains tax upon the sale of the gifted property sometime in the future. If an estate being subject to estate tax is not a concern, the decision to give a gift should be based on other factors.

Other factors include gifts to a relative to assist in buying a home or starting a business. However, a donor should withhold from gifting appreciated property because of the capital gains tax that may be realized at a later date upon the sale of the asset by the recipient. In contrast, if the appreciated property is held by the donor until their death, the heir will receive a step-up in basis causing any capital gains tax on pre-death appreciation to be non-existent.

Spouse’s estate

Portability gives married couples more flexibility in deciding how they want to use their exclusion amounts. Portability is the ability to apply the decedent’s unused exclusion amount to the surviving spouse’s transfers during life and at death which is an effective tool for estate planning. Once this election is made, portability enables the surviving spouse the ability to apply the unused portion of a decedent’s applicable exclusion amount in the year of the decedent’s death.

Estate or valuation discounts

As times are changing, some estate exclusion or valuation discount strategies may not be worth pursuing. Instead, it may be better to include the property in the estate or not qualify for valuation discounts to ensure the property receives a step-up in basis. For example, the valuation of qualified real property, such as a building used for farming, may not be beneficial in saving estate tax to justify giving up the step-up in basis that would occur otherwise.

With the current high exemption of $12.06 million in 2022, many taxpayers are not concerned with estate tax, but it is still important to plan how to save income taxes. For example, be cautious in transferring appreciated assets during life, as there may be a more tax-beneficial option available. Such as holding the assets until post-life to give the heir a step-up in basis to reduce or cancel out any potential capital gains tax.

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