Tax Advisor 2019

The passage of the Tax Cuts and Jobs Act (TCJA) on December 22, 2017, brought about a temporary increase in the lifetime estate and gift tax exemption amount to $11.4 million per taxpayer in 2019, adjusted for inflation. For estates with a value below the $11.4 million exemption amount ($22.8 million for a married couple), there’s a significant shift in planning from estate tax reduction to income tax basis planning. When a person dies owning an asset or possessing certain powers over an asset, the tax basis of the asset is adjusted to its fair market value on the decedent’s date of death. If the tax basis of the asset is less than its fair market value at death, the tax basis is “stepped up” to the date-of-death value. Below are some strategies that could be implemented to increase tax basis and save income taxes in the future. When evaluating these strategies, keep in mind the increased exemption is currently scheduled to revert back to pre-TCJA amounts in 2026 ($5 million per taxpayer, adjusted for inflation).

Understanding Which Assets Benefit from a Step-Up in Tax Basis
It’s important to understand which assets will benefit from a step-up in tax basis. A highly appreciated asset will typically benefit the most, while an asset that is depreciated or has a tax basis equal to its fair market value will not benefit at all. Asset types that typically benefit the most from a step-up in tax basis include: intellectual property owned by its creator, oil and gas interests, collectibles, highly appreciated stock and real estate. 

“Do Nothing” Planning (Die Owning Assets)
The simplest way to ensure the tax basis of an asset is stepped up at death is to own the asset until death. Using this strategy, you should reduce lifetime gifting of appreciated property and instead consider using cash or other high-tax-basis property when making gifts to family. 

Undo Prior Planning
A common strategy to reduce the value of assets includible in a taxpayer’s estate, and thus any estate tax, is through the use of valuation discounts. This includes strategies such as the creation of limited partnerships or limited liability companies with restrictions on transferability and control. Taxpayers who have previously implemented this strategy but are now below the estate tax exemption amount may benefit from undoing this prior planning by liquidating the entity to eliminate any valuation discounts and potentially create a larger tax basis step-up at death. 

Upward Gifting
One strategy to achieve a step-up in tax basis involves gifting appreciated assets to an aging parent who will not owe estate or inheritance taxes at their death. Upon the parent’s death, the assets would receive a step-up in tax basis. The parent could bequest these assets back to the donor child or to someone other than the donor child. 

A rule to be aware of when implementing this strategy is the one-year rule contained in Internal Revenue Code (IRC) Section 1014(e). Under IRC §1014(e), if appreciated property was acquired by gift within one year of death and the gifted property passes back to the original donor of the property, no step-up in tax basis is achieved. When using this strategy, the two primary ways IRC §1014(e) is avoided and a step-up in tax basis is achieved are:

  1. Parent lives beyond one year from the gift date
  2. Parent leaves the assets to someone other than the original donor

An in-depth analysis of IRC §1014(e) is beyond the scope of this article. Other nontax issues, such as lost control of the assets and parental creditor or marital issues, should be considered before implementing this strategy.

Trust Decanting
Some trusts were established years ago when the estate tax exemption was relatively low ($1 million in 2003) and portability (the transfer of unused estate tax exemption to a surviving spouse) was not available. Now with the increased estate tax exemption and portability, some existing trusts may not serve the purpose for which they were originally intended.

Decanting is the process of pouring assets of one irrevocable trust into a new irrevocable trust with different and more desirable terms. Decanting can be useful for tax basis planning if the assets of a trust are appreciated but aren’t currently includible in an individual’s estate and that individual will not be subject to estate tax at their death. In this case, a trust could be decanted to a new trust that grants a general power of appointment to the desired individual, which would cause estate tax inclusion and allow the tax basis of the trust assets to be stepped up at death.

Trust Substitution
A popular estate planning strategy involves the sale of assets to an intentionally defective grantor trust (IDGT). This type of trust is treated as a grantor trust for income tax purposes because the trust permits the grantor to substitute assets with the trust of an equivalent value. Since this type of trust is not includible in the estate of the grantor at death, no step-up in tax basis is achieved on appreciated assets inside the trust. A strategy to achieve a step-up in tax basis on these assets is for the grantor to substitute high basis assets, e.g., cash, for the appreciated assets currently inside the trust of equivalent value. After the substitution, the appreciated assets would be part of the grantor’s estate and receive a step-up in tax basis upon death.

When considering this strategy, the potential estate tax cost of any appreciation of the substituted asset versus the income tax savings of a step-up in tax basis should be considered.

As the adage goes, “Don’t let the tax tail wag the dog.” Tax reduction is important, but sometimes it’s not the first priority. As with all tax planning strategies, both tax and nontax issues should be considered when implementing the above strategies, including, but not limited to, state estate or inheritance taxes, age or health of the taxpayer, future legislative changes, creditor issues and control. 

Reach out to your BKD trusted advisor or complete the Contact Us form below if you have any questions or for more information.

FORVIS Private Client services may include investment advisory services provided by FORVIS Wealth Advisors, LLC, an SEC-registered investment adviser, and/or accounting, tax, and related solutions provided by FORVIS, LLP. The information in this presentation should not be considered investment advice to you, nor an offer to buy or sell any securities or financial instruments. The services, or investment strategies, mentioned in this presentation may not be available to, or suitable, for you. Consult a financial advisor or tax professional before implementing any investment, tax, or other strategy mentioned herein. The information herein is believed to be accurate as of the time it is presented and it may become inaccurate or outdated with the passage of time. Past performance does not guarantee future performance. All investments may lose money.

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