The estate tax is no longer the beast to be tamed. It's not dead, mind you, but at least these days the estate tax isn't causing such a fuss as in recent history. But waiting in the wings there is another tax monster that you cannot afford to ignore.
The capital gains tax.
The budget deal of January 1, 2013, locked in a high estate tax exclusion amount and enshrined the ability for spouses to pass unused estate tax exemption amounts between themselves (so called, “portability”). In the same swoop, though, the capital gains tax jumped up another 8.3% to 23.8% from the previous 15%.
So how does the increased capital gains tax affect your estate plan? This is a question Forbes explored in a recent article interestingly titled “Freebasing Your Estate.”
The core of the issue with capital gains is “cost basis,” a term for the original value against which the present value is compared to determine the taxable portion of capital gain. To illustrate, let's say you bought shares of stock or a piece of property many years ago for $10,000. If you sell that stock or property today, when it is worth $100,000, you will have to pay capital gains tax on the $90,000 difference between your cost basis and the sale price. So it is usually better to have a higher basis in an asset that could generate a capital gain when you sell it.
A “postmortem (at death) bequest” and an “intervivos (during life) gift” may transfer an asset with the same value. However, they transfer a different cost basis to the inheritor and donee, respectively. The inheritor gets to use the “date of death” value as the basis of the inherited asset. This is known as “stepped up” basis. The donee (the person who receives the lifetime gift) receives and continues to hold the same basis held by the donor. This is known as “carryover” basis. Going back to the example of the asset purchased for $10,000 but with a current value of $100,000, would you rather receive it by gift or by inheritance? Unless you are a huge fan of paying taxes, you would want to receive it by inheritance, because that way your basis in the asset would be its fair market value as of your benefactor's date of death.
With the estate tax now less of a concern for your estate plan, it makes more sense to transfer an asset at death rather than during your lifetime, all other considerations being equal.
What assets will you be transferring? Is the estate tax or is the capital gains tax a greater threat to your family wealth? Considering all this, you must still remember: what Congress puts into place it can just as easily undo. It pays to stay on top of how changes in the law can affect you and your family.
Reference: Forbes (February 12, 2014) “Freebasing Your Estate”