Judelson, Giordano and Siegel, CPA, PC is more than just a highly respected Hudson Valley accounting firm; they are business advisers, reaching beyond the numbers to address core business concepts and operational matters that impact the growth and protection of their clients’ businesses and assets. When they accepted our request to share their wisdom with you — our readers — we were thrilled. We know you will be, too.
A Work in Progress
An uncertain future requires a flexible estate plan
If your life expectancy is 30 years or more, it may be difficult to plan for the future: Should you make lifetime gifts to reduce estate tax liability? Or should you keep the assets in your estate to try to minimize the potential income tax burden on your loved ones? Adding flexibility to your estate plan is key, and a carefully constructed trust is the proper vehicle.
Estate tax planning vs. income tax planning
When you transfer assets at death, your tax basis is “stepped up” to the assets’ current fair market value, allowing your heirs to sell the assets without recognizing capital gains. When you transfer assets via gifts, however, they retain your basis, so recipients who sell appreciated assets may face a big tax bill. From an income tax perspective, it’s usually best to keep assets in your estate and transfer them at death.
Estate tax planning, on the other hand, generally favors lifetime gifts. By transferring assets to the younger generation as early as possible — either in trust or outright — you remove those assets from your estate while their values are low, thus minimizing gift taxes. This also shields future appreciation from estate taxes. The best strategy is the one that will produce the greatest tax savings for your family. But if you wait until you know the answer, it may be too late. Let’s look at an example. Kim, 40, has a net worth of $5 million. In 2016, she transfers $1 million in stock (with a $500,000 tax basis) to an irrevocable trust for the benefit of her son, John. When Kim dies 30 years later, the stock’s value has grown to $6.5 million. By giving the stock to John in 2016, Kim avoided estate tax on $5.5 million in appreciation. However, because the stock retains Kim’s $500,000 basis, John will incur a $1.2 million capital gains tax (assuming a 20% rate) if he sells it. Assume that, when Kim dies in 2046, her net worth remains at $5 million and the inflation-adjusted estate tax exemption is $12 million. Even if Kim had kept the stock, her estate would have been exempt from tax. Thus, there was no advantage to giving it away. And, if she had transferred the stock at death, John would have gotten a stepped-up basis, which means that he would have little or no capital gains tax liability if he sold the stock shortly after Kim’s death. Under these circumstances, keeping the stock in Kim’s estate would have been the better tax strategy.
Suppose, instead, that in 2046 Kim’s net worth (apart from the stock) has grown to $10 million. Keeping the stock would increase her estate to $16.5 million, generating a $1.8 million estate tax (assuming a 40% tax rate). Given these facts, the estate tax savings are significantly larger than the potential income tax cost. So the family is better off if Kim removes the stock from her estate in 2016. Bear in mind that this example is oversimplified for illustration purposes. To determine the right strategy, you also need to consider state income and estate taxes, as well as your beneficiary’s future plans.
Give your trustee power
It’s difficult to predict your family’s financial situation, and the state of estate and income taxes, decades from now. But with a carefully designed trust, it’s possible to hedge your bets, giving the trustee the ability to switch gears when the best course of action reveals itself.
Here’s how it works: You transfer assets to an irrevocable trust for the benefit of your heirs, relinquishing control over the assets and giving the trustee absolute discretion over distributions. The assets are removed from your estate, minimizing gift and estate taxes.
If, however, it becomes clear that estate tax inclusion is the better tax strategy, the trustee has the power to force the assets back into your estate.
Planning for the future
If you’re in your 20s or 30s, there are many variables to consider when creating or updating your estate plan. Choosing certain strategies today may not be advantageous decades from now. Flexibility is important, but so is using caution; risks are involved.
Your estate planning advisor can explain the potential pitfalls before you take action.
Bonnie J. Orr, CPA, is a shareholder of Judelson, Giordano & Siegel, CPA, PC. Bonnie began her career in public accounting in 1981.
In addition to providing tax and accounting advice to a wide range of closely held businesses, Bonnie specializes in the area of estates and trusts. Bonnie works closely with clients and their attorneys, providing estate and personal tax planning strategies to maximize the transfer of wealth to future generations, and provide for a long and comfortable retirement without losing sight of a client’s current financial needs.
Bonnie has worked extensively in the complex areas of the generation skipping tax, living trusts, life insurance trusts, personal residence trusts, charitable remainder trusts, special needs trusts and family limited partnerships.
Bonnie currently serves as an officer and board member of several local charities. She is also a past president of the Hudson Valley Estate Planning Council.
Bonnie received her Bachelor of Science degree from LeMoyne College. She is a member of the American Institute of Certified Public Accountants and the New York State Society of Certified Public Accountants.