Inherited Property: What is Step Up in Basis? Discussion with Cherie Williams, CPA of The Little CPA
Jennifer collaborated with Cherie Williams, CPA, founder of The Little CPA, on the topic of inheriting assets. Cherie created The Little CPA to empower purpose-driven professionals to make wise financial decisions that build diligent wealth.
Inherited Property: What is Step-Up in Basis? – The Little CPA
(The Little CPA empowers purpose-driven professionals to make wise financial decisions that build diligent wealth.)
Time is of the Essence for High-Net Worth Estates
Potential Changes in Estate Tax Laws
You may have heard about the most recent House proposal in September, 2021 that addresses changes to the tax law, which will cover the costs of a massive ($3.5 trillion) proposed spending package. There have been various proposals since President Biden was elected that target an increase in various taxes. Until now, none of the prior proposals have successfully passed. This might be a different scenario.
Brief Summary of Recent Estate Tax History
Most of the current popular tax concerns, such as income, estate, gift, and corporate taxes, are governed by the Tax Cuts and Jobs Act (TCJA). The TCJA was effective as of January 1, 2018 and is set to sunset on December 31, 2025. The sunset provision means that the tax laws that were in effect on December 31, 2017 will again govern beginning in 2026.
The current (i.e., 2021) estate tax exemption is a whopping $11,700,000 per person, which can be doubled for married spouses with intentional planning for a total of nearly $24,000,000. The estate tax exemption generally increases each year for inflation. Under the TCJA, the increased exemption will revert back to 2017 exemption of $5,490,000, adjusted for inflation, or approximately $6,000,000, beginning on January 1, 2026.
What is important in the House Proposal for Estate Tax Planning?
I. Capital Gains Taxes Increase
The rate of capital gains will increase to 25%, which is 5% higher than the current 20%. The 25% is closer in line to what it was prior to the TCJA. Capital gains taxes are an important consideration when transferring or selling assets during life. The 5% increase may be substantial for assets that have significant built-in capital gains. Two common scenarios are real estate and small businesses.
For example, if someone purchased real estate 30 years ago with an adjusted cost basis of $150,000, and the property is now worth $2,000,000 (i.e., built-in gains of $1,850,000), the 5% increase in capital gains results in $92,000 more in capital gains tax, for a total capital gains tax of $462,500. This is only FEDERAL capital gains tax. If you live in an area such as New York City, you can add up to 25% to the capital gains tax without taking advantage of other estate planning tools (i.e., Delaware Asset Protection Trusts, 1031 Exchange, Charitable Trusts, etc.).
What to do: Discuss with your attorney or accountant whether certain assets might benefit from being sold this year while the capital gains tax is still at the lower rate.
II. Federal Estate Tax Exemption Reduced Sooner than 2026
As summarized above, the current estate tax exemption is set to expire December 31, 2025 and reduced to 2017 levels of approximately $6,000,000. The Proposal would accelerate the effective date to January 1, 2022.
For estates that are greater than $6,000,000, they will essentially lose an equivalent amount that can be given away estate tax-free during life or at death.
What to do: Discuss with your attorney how to reduce your estate by making gifts or otherwise transferring portions of your estate while the exemption is still $11.7 million.
III. Grantor Trust Rules for Income Tax Purposes will be Eliminated
Trusts which are treated as owned by the Grantor for income tax purposes (i.e., Grantor Trusts) will be deemed as owned by the Grantor for estate tax purposes as well. This means that most common trusts used for estate tax planning purposes will be included in the Grantor’s taxable estate. This includes Grantor Retained Annuity Trusts (GRAT), Irrevocable Life Insurance Trusts (ILIT) or Spousal Lifetime Access Trusts (SLAT), just to name a few.
Explanation of Grantor Trusts
Grantor Trusts are a great tool for estate planning in that it allows the Trust assets to grow without the Trust assets being utilized to pay the Trust’s annual income tax. In addition, as the Grantor pays the Trust’s income tax annually, the Grantor’s estate continues to be reduced. Any assets in the Trust are excludible from the Grantor’s estate as it is considered a completed lifetime gift.
Under the Proposed rules, any Grantor Trusts created after the effective will be included in the Grantor’s estate for estate tax purposes. In addition, existing Grantor Trusts that receive additional contributions will also be included in the Grantor’s estate. The timing is for any trust that is created after the EFFECTIVE DATE, which is the date the proposal is approved (could be in 2021).
What to do: Discuss with your attorney whether you should URGENTLY CREATE AND FUND certain trusts before the EFFECTIVE DATE. Remember, under the current rules, the effective date might be earlier than January 1, 2022. Any delay can create a significant impact in the amount of estate taxes that your estate might have to pay when you die.
IV. Other Proposals that Might Impact Estate Planning
Valuation Discounts May be Eliminated
Many individuals have an interest in a corporation or limited liability company for purposes of liability protection and not for running an operating business. Under the current rules, discounting for these types of assets may be eliminated.
What to do: Make an inventory of your current holdings and determine with your attorney or accountant which ones are operating a business and which are being held for non-operating purposes. Determine if any changes can and must be made.
Back-Door IRA Conversions May be Limited
Current law does not allow individuals to make contributions to a Roth IRA if their income exceeds a certain level. However, these same individuals can get around the limitation rule by first contributing to a non-deductible traditional IRA and then converting to a Roth IRA. The primary benefit of a Roth IRA is that any increase in value over time is not includible in the annuitant’s income taxes when withdrawals are made during retirement. The Proposal would disallow Roth conversions for taxpayers whose taxable income exceeds $450,000 for married taxpayers filing jointly or $400,000 for single taxpayers or married taxpayers filing separately.
What to do: Discuss with your financial advisor your options in converting certain traditional IRA account to Roth IRA accounts and with your accountant the tax impact of the conversion.
Take Action Now
There are many other proposals that impact various areas of the tax law. Some have more chance of being adopted than others. However, it is very likely that a change will affect and limit estate tax planning options.
If you have any questions on the areas of the tax law that impact your estate and asset planning, please do not hesitate to contact me.
When to Review or Revise your Estate Documents
There are certain times when you should consider reviewing your estate documents to determine if they still meet your needs. Sometimes it is based on specific relationship and life events, such as marriage, divorce, birth of a child, or death of a loved one. Other times it is based outside events, such as on the passage of time, growth of your estate value, changes in the law or desire for a different distribution of your estate.
Relationship and Life Events
A life event is generally an obvious time to review your estate plan and consider making changes. Because the life event affects you directly, you are able to know when a change to your documents might be necessary. If you have worked with me in the past, you might recall me saying that your Will is flexible for certain life changes. Even so, it is prudent to review the documents to consider if it would be best to update the estate plan to reflect your current life circumstances.
Marriage or Divorce
A change in your life circumstances may be causing you to reconsider the distribution of your estate, whether by your own choice or by law. In particular, New York State law (EPTL Sec. 5-1.1-A) requires that you provide a portion (approximately 1/3) of your estate to your spouse. In the absence of a pre-nuptial agreement, it may be necessary to revise your documents accordingly. If you become divorced, you may have to revise your estate plan to comply with a Separation Agreement or Judgment of Divorce.
Birth or Death
The birth of a child is always a cause for celebration! You may want to include the child as a beneficiary of your estate or create a trust for the child. You will want to consider who to appoint as guardian of your child if both parents are deceased. This may be a difficult decision to make, but this should not deter you from finalizing your Will because you can always update the appointments later. Without naming a guardian, it will be up to the Court to determine who is the best person to care for the child and it may not be your first choice.
If someone named in your Will dies, consider revising the Will to clear any confusion as to the person’s bequest. You may want to change the distribution of your estate as a result of the person’s death. It is just as important to consider revising your Will or Trust if a named fiduciary dies. You will be able to appoint a successor to ensure there is no gap in administration of your estate or trust.
Outside Circumstances
It is important to be aware of outside circumstances, such as those without a specific identifiable life event, which may affect your estate.
Passage of Time
Clients frequently ask me when they should review their estate documents. If there is no life event, your estate documents may work just as well many years after being finalized. But a good rule of thumb is to review your documents every two or three years. It’s as simple as reading through the documents you have and deciding if you want to make any changes. As you read the documents, consider if you have any questions on the impact of certain provisions or changes in the law.
Growth of Your Estate Value
If you notice that the value or your assets has appreciated since your estate documents were finalized, you should consider reviewing them to determine if tax planning is necessary or beneficial.
The growth of your estate may also provide additional options for distribution of your estate. This includes adding new beneficiaries, creating trusts or providing for charities.
Changes in the Tax Law
For most of us, it is easy to become aware that there has been a change in the tax laws. When such a law is passed, you should review your estate documents to consider if the tax law may impact your current estate plan.
Estate tax planning can only be done while you are alive through your Will, trusts or gifting. If you die intestate or with documents that do not include proper drafting specific to minimize estate taxes, your estate will be subject to estate tax that could have been avoided.
Desire for a Different Distribution of Your Estate
It is common for individuals to revise their documents to modify the distribution of their estates. This may include adding or removing a beneficiary, changing bequests, providing for a disabled beneficiary or modifying a named fiduciary.
Some changes, such as modifying a named fiduciary, may be done easily by use of a Codicil. Substantive changes generally require preparing a new Will or amending and restating an existing revocable Trust.
Be Proactive in Updating Your Estate Plan
Estate planning requires you to makes serious decisions about people and matters that you care about. You may want to “set it and forget it” once your documents are finalized, but don’t let your estate wishes become stale or ineffective because your circumstances changed since finalizing your estate.
If you are considering changing your estate documents, please do not hesitate to contact me. If I previously prepared your estate documents, I will be happy to review the documents and have a brief complimentary discussion on whether changes should be made.
Basics of Estate Planning
Estate planning is a broad term for preparing your assets and your family’s needs in the event of your disability of death. The type of planning appropriate for you will depend on the composition of your assets, your family structure and dynamic, the value of your estate, or your country of residence.
Estates Come in all Shapes and Sizes
What do you think about when you hear the term “estate” planning? It’s possible you may be thinking that an estate exists only if there is significant wealth, multiple assets, or many family members. But an estate exists as soon as you have any asset in your name, regardless of the value.
Smaller estates may only require very basic planning, such as a Will, Health Care Proxy and Living Will, and Power of Attorney. A larger estate may benefit from additional estate and income tax planning, creation of trusts, or structuring the sale or distribution of a family business.
The estate planning is tailored for your needs. Although it may seem simple enough, the process to consider who receives your assets is as unique as you are.
Take Action During Family of Financial Milestones
A good time to prepare an initial estate plan or review your existing plan is when there is a family or financial milestone in your life. Common milestones include marriage, birth of a child, divorce, purchase of a home, retirement or increase in wealth.
Prepare a Will
Individuals sometimes ask me if they REALLY need a Will. As a trust and estates lawyer for over 10 years, I can unequivocally say the answer is YES!
If you die without a Will, the State (or country) of your primary residence will determine who receives your estate and in what portions. This does not mean that the State gets your assets – only that your estate will be distributed according to their rules. You may not like the default distribution. A Will or Trust allows you to override the default distribution in accordance with your wishes.
Distribution without a Will (Intestacy)
Generally, spouses cannot be disinherited (unless there is a pre- or post-nuptial agreement). Statutory intestacy rules may provide that the remainder of your Estate must be distributed to equally to your children, grandchildren, or your parents. This may not be the best distribution for your family.
In particular, if you have minor children, it is preferable to have their share held in a trust until they reach a certain age. Without a Will or Trust, you would be unable to do this and the child would receive the entire distribution at age 21. The risk of a full distribution at age 21 is that the child may splurge it all at one. Most parents prefer that the child’s assets be held for their benefit until a later age – 35, 40 or even longer – so that the child has access to funds at various milestones.
Additional Benefits of a Will or Trust: You call the shots!
A testamentary document, such as a Will or Trust, allows you to decide who will manage the administration of your Estate by appointing an Executor or Trustee. By clearly identifying an individual, your family members will not have to decide who should (or shouldn’t) be in charge.
You can also provide that the Executor or Trustee may serve without filing a bond. The default in many States requires that the Administrator file a bond, which can be costly for the estate and create delays in collecting the assets. By avoiding a bond, your assets can be collected sooner and distributed to your beneficiaries without the expense of a bond.
If you have minor children, you can designate a preferred guardian if both parents are deceased. During such a difficult time, your children would benefit from having the security of a designated guardian without having relatives argue over who is best suited to care for the child.
Estate Taxes
Federal law allows an individual a lifetime estate and gift tax exemption of $13,610,000 (for 2024). New York law provides an exemption of $6,940,000. These are historically high exemption amounts. Although the values usually increase annually, there have been instances where these values went down.
If your estate is near either of these values, you should consider various estate planning strategies now to reduce your estate tax exposure. This may include creating lifetime trusts, making gifts to your heirs during life, or giving a portion to charity.
Next Steps
A skilled estate planning attorney can provide tailored options for your assets and family structure.
Do not hesitate to contact me if you need assistance with your estate planning.