Give It or Lose It!


I was recently working with a family on their estate plan that involved circumstances and decisions that could save hundreds of thousands of dollars in taxes if they take action this year. Before I get into the details allow me to set the context for potentially massive tax law changes that will occur next year should Congress fail to take decisive action.
Under current law, your heirs are not subject to estate taxes at death unless your estate exceeds $5 million. If you are married, each spouse has a $5 million estate tax exemption. Finally, there are no estate taxes for transfers to a spouse at death. If your estate exceeds this amount, the excess is taxed at 35%. All of this changes on January 1, 2013 when a sunset provision under the current law automatically reduces the $5 million estate tax exemption to $1 million ($2 million for married couples) and raises the tax rate to 55%.
Back to my family case example. The wife’s father was a successful executive whose current estate is about $3 million. An amazing man, he’s 93 and still lives in the family home. Clearly, at age 93, he’s not going to outlive his money. If his death occurs after this year, the children would owe over $1 million in death taxes. Well that’s not a pleasant thought particularly if you could do something to reduce or eliminate the tax. In fact there is a simple strategy that could eliminate the estate tax. For 2012, anyone can give away up to $5 million of assets ($10 million for married couples) without paying any gift taxes. In other words, for this year, you get a $5 million exemption from taxes for either gifts or at death. For this case I recommended that the father make a one-time gift of $2 million to his two daughters leaving him $1 million. This $1 million in addition to his Social Security and pension is more than sufficient to meet his lifestyle expenses for the rest of his life. His daughters are the sole beneficiaries of his estate and by making the gift this year, they potentially save over $1 million in future estate taxes. 
In choosing which assets to give versus which to retain, he’ll want to keep assets that have a low cost basis. This is because gifted assets retain the same cost basis whereas inherited assets receive a step-up in cost basis based on the value at the date of death. For example, let’s say he owned IBM stock worth $100,000 that he had paid $10,000 for decades ago. If he gifts the stock to the daughters, they’ll now own IBM worth $100,000 with a cost basis of $10,000. Should they choose to sell the stock, they’ll owe taxes on the $90,000 of gains. However, if they received this same stock as an inheritance, the cost basis of $10,000 gets a ‘step-up’ in basis to $100,000. Now if they sold it, the tax would be zero.
What this means to you. You don’t have to be 93-years-old to take advantage of this strategy. If you have a parent who you suspect is worth over $1 million, give them a copy of this article. If you are a parent worth over $1 million, realize there are a number of tax reducing strategies that could save potentially hundreds of thousands of dollars in taxes if you take action this year. Contact your estate planning attorney or your financial advisor to review your current estate plan in light of major rule changes that are scheduled to occur next year. Tic-toc, tic-toc…that’s the sound of time running out. 
IMPORTANT NOTE: See next week’s column “Give It or Lose It!” for a correction and further discussion on this topic.