Can You Explain the Concept of Step-Up Basis? – Annapolis and Towson Estate Planning

If you inherit assets—especially real property—you need to understand the step-up in basis rules. These rules can save you a lot of money on capital gains and depreciation recapture taxes.

Motley Fool’s recent article on this subject asks “What is a Step-Up in Basis?” The article explains that step-up in basis has significant implications for inherited property. When an asset is inherited because the original owner has passed away, in many cases, it’s worth more than when it was first purchased. To avoid a huge capital gains tax bill when the inherited property is sold, the cost basis of the asset is modified to its value at the time of its owner’s death. This is called a step-up in basis. Note that this only applies to property transferred after death. If a property was gifted or transferred before the original owner dies, the original cost basis would transfer to the recipient.

This is a gigantic tax benefit for estate planning, regardless of whether you go ahead and sell the inherited asset immediately or hold on to it for a time. While a step-up in basis can let heirs avoid capital gains taxes, it doesn’t allow heirs to avoid estate taxes that apply to big inheritances.

The estate tax this year is imposed on property in excess of $11.4 million per individual and $22.8 million per married couple. Therefore, if you and your spouse leave a $25 million estate to your heirs, $2.2 million of this will still be taxable, even though your heirs’ cost basis in assets they inherited will be stepped up for capital gains tax purposes.

There are many strategies that a qualified estate planning attorney can advise you on to avoid estate taxes, but step-up in basis doesn’t exclude the value of inherited property from a taxable estate all by itself.

There are two significant ramifications of stepped-up cost basis regarding inherited real estate assets. First, like with other assets, you don’t have to pay capital gains on any appreciation that occurred before you inherited the property. Selling an investment property after years of holding it, can mean a massive capital gains tax bill. Therefore, a stepped-up cost basis can be a very valuable benefit. A step-up in basis can also give you a larger depreciation tax benefit. The cost basis of residential real estate can be depreciated (deducted) over 27½ years: a higher number divided by 27½ years is a greater annual depreciation deduction than a smaller number would produce.

Estate transfers are pretty complicated, so work with a qualified estate planning attorney.

Reference: Motley Fool (November 21, 2019) “What is a Step-Up in Basis?”

Sims & Campbell, LLC – Annapolis and Towson Estate Planning Attorneys

What Happens to Estate Tax Benefits After 2025? – Annapolis and Towson Estate Planning

You may recall that the 2017 Republican tax reform legislation roughly doubled the estate and gift tax exemption.

This means starting in 2019, people are permitted to pass on, tax-free, $11.4 million from their estate and gifts they give before their death. Couples can pass on twice that amount, or $22.8 million.

These higher levels expire in 2026, but those who make large gifts while the exemption is higher and die after it goes back down, won’t see the estate tax benefit eroded, the IRS announced recently via new regulations.

“As a result, individuals planning to make large gifts between 2018 and 2025 can do so, without concern that they will lose the tax benefit of the higher exclusion level once it decreases after 2025,” the agency said in a press release.

Yahoo Finance’s recent article, “IRS Says Millionaires Can Keep Estate Tax Benefits After 2025,” says that the exemption increase was a big priority for Republicans in the 2017 tax overhaul.

This exemption decreased the number of individuals who’d be subject to the 40% estate tax by about two-thirds.

The exemption was $5.5 million prior to the law change.

However, Democrats are looking to reverse those changes, if they sweep the House, Senate and White House in the 2020 national elections.

Nearly every Democratic presidential candidate would like to see the estate tax apply to a greater number of wealthy families.

Senator Bernie Sanders has called for the estate tax, to begin when fortunes are worth at least $3.5 million. He has also proposed rates as high as 77%.

Reference: Yahoo Finance (November 22, 2019) “IRS Says Millionaires Can Keep Estate Tax Benefits After 2025”

Sims & Campbell, LLC – Annapolis and Towson Estate Planning Attorneys

Will My Heirs Need to Be Ready to Pay Estate Taxes? – Annapolis and Towson Estate Planning

Estate taxes all depend on how on much a person is planning to give to heirs.

Motley Fool’s recent article asks “If I Leave My Retirement Savings to My Heirs, Will They Pay Estate Tax?” The article tells us that retirement accounts like 401(k)s, 403(b)s, traditional and Roth IRAs and others are a part of your taxable estate.

However, unless the total assets of your estate plus any taxable gifts you’ve already given are more than the lifetime exclusion amount, your estate won’t owe estate taxes.

For 2019, this is $11,400,000, and in 2020, the exclusion will be raised to $11,580,000. If you total all of your assets’ value, only the amount in excess of the exclusion will be taxable. Therefore, if you have a $12,000,000 estate and die in 2020, only $420,000 of your assets would be subject to estate taxes.

Let’s look at another example: if your assets, including your retirement savings, total up to $5 million, your heirs won’t be required to pay any estate tax whatsoever.

However, while they may not have to pay estate taxes, remember that withdrawals from most retirement accounts (except Roth IRA accounts) will be deemed to be taxable income. Thus, estate tax or no estate tax, if your heirs are in a pretty high tax bracket, inheriting your retirement savings may increase their tax liability.

Don’t neglect to check with an estate planning attorney about your state’s estate and inheritance taxes. There are a handful of states that have their own estate taxes, and their thresholds may be lower than the IRS’s.

There are now six states with an inheritance tax: Iowa, Kentucky, Maryland, Nebraska, New Jersey and Pennsylvania.

Each state sets its own inheritance tax exemption, and inheritance tax rates. However, these rates are subject to change at any time with changes to the laws in those states.

Reference: Motley Fool (November 8, 2019) “If I Leave My Retirement Savings to My Heirs, Will They Pay Estate Tax?”

Sims & Campbell, LLC – Annapolis and Towson Estate Planning Attorneys

New IRS Regulations Won’t Claw Back Estate Tax Benefits – Annapolis and Towson Estate Planning

The IRS published regulations on Friday that there will not be a claw back in the event exemptions are reduced in 2026, when the current tax levels expire. We recommend clients consider making lifetime gifts to use some of the federal estate tax exemptions before the exemption is reduced.

Please feel free to give us a call if you would like to discuss this further.

IRS Says Millionaires Can Keep Estate Tax Benefits After 2025

Sims & Campbell, LLC – Annapolis and Towson Estate Planning Attorneys

What is Portability and How Does It Impact Estate Planning? – Annapolis and Towson Estate Planning

Let’s address the elephant in the room: the word “estate” in planning doesn’t have anything to do with the size of your home. It simply refers to a person’s assets: their home, bank accounts, a second home, investment accounts, cars, etc.

The federal estate tax, says The Times Herald in the article “Federal estate tax and portability considerations,” impacts very few people today, as a person would have to have assets that total more than $11.4 million (or $22.8 for a couple) before they have to worry about the federal estate tax.

Individuals and couples with significant assets are advised to have an estate plan created by an estate planning attorney with experience working with people with large assets.  There are numerous tools used to minimize the federal tax liability.

However, when one spouse dies, it is generally recommended that the surviving spouse file a Federal Estate Tax return for reasons of portability. That is because when the first spouse dies, they use a portion of the Federal Estate Tax exemption, but there’s usually a portion available for the surviving spouse.

If IRS Form 706 is filed in a timely manner, the surviving spouse can “port over” or protect the remaining amount of Federal Estate Tax exemption that the deceased spouse has not used. This return needs to be filed within nine months of the date of death, although the surviving spouse can obtain an extension.

No tax will be owed, since the return is filed merely for reporting purposes. The assets in the entire estate must be reported, including everything the person owned. That may be cash, securities, real estate, insurance, trusts, annuities, business interests, and other assets. It should be noted that this will likely include probate as well as non-probate property. Appraisals and significant documentation are not usually required on a return just for portability purposes.

Why does a return need to be filed to claim the unused exemption, if no taxes are going to be paid? For one thing, the law may change and if the Federal Estate Tax exemption amount is reduced in the future, the surviving spouse will have protected their additional exemption amounts for his or her heirs. If the surviving spouse remarries and acquires significant assets, they will need proof of their exemption. The surviving spouse might own land or other property that increases dramatically in value. Or, the surviving spouse may inherit a large amount of assets.

Completing an IRS Form 706 for portability is not a complex task, but it should be done in conjunction with settling the estate, which should be done with the help of an estate planning attorney to be sure any tax issues are dealt with properly. In addition, when one spouse has passed, it is time for the surviving spouse to review their estate plan to make any necessary changes.

Reference: The Times Herald (July 7, 2019) “Federal estate tax and portability considerations”

Sims & Campbell, LLC – Annapolis and Towson Estate Planning Attorneys

Are Inheritances Taxable? – Annapolis and Towson Estate Planning

Inheritances come in all sizes and shapes. People inherit financial accounts, real estate, jewelry and personal items. However, whatever kind of inheritance you have, you’ll want to understand exactly what, if any, taxes might be due, advises the article “Will I Pay Taxes on My Inheritance” from Orange Town News. An inheritance might have an impact on Medicare premiums, or financial aid eligibility for a college age child. Let’s look at the different assets and how they may impact a family’s tax liability.

Bank Savings Accounts or CDs. As long as the cash inherited is not from a retirement account, there are no federal taxes due. The IRS does not impose a federal inheritance tax. However, there are some states, including Iowa, Kentucky, Maryland, Nebraska, New Jersey and Pennsylvania, that do have an inheritance tax. Speak with an estate planning attorney about this tax.

Primary Residence or Other Real Estate. Inheriting a home is not a taxable event. However, once you take ownership and sell the home or other property, there will be taxes due on any gains. The value of the home or property is established on the day of death. If you inherit a home valued at death at $250,000 and you sell it a year later for $275,000, you’ll have to declare a long-term capital gain and pay taxes on the $25,000 gain. The cost-basis is determined when you take ownership.

Life Insurance Proceeds. Life insurance proceeds are not taxable, nor are they reported as income by the beneficiaries. There are exceptions: if interest is earned, which can happen when receipt of the proceeds is delayed, that is reportable. The beneficiary will receive a Form 1099-INT and that interest is taxable by the state and federal tax agencies. If the proceeds from the life insurance policy are transferred to an individual as part of an arrangement before the insured’s death, they are also fully taxable.

Retirement Accounts: 401(k) and IRA. Distributions from an inherited traditional IRA are taxable, just as they are for non-inherited IRAs. Distributions from an inherited Roth IRA are not taxable, unless the Roth was established within the past five years.

There are some changes coming to retirement accounts because of pending legislation, so it will be important to check on this with your estate planning attorney. Inherited 401(k) plans are or eventually will be taxable, but the tax rate depends upon the rules of the 401(k) plan. Many 401(k) plans require a lump-sum distribution upon the death of the owner. The surviving spouse is permitted to roll the 401(k) into an IRA, but if the beneficiary is not a spouse, they may have to take the lump-sum payment and pay the resulting taxes.

Stocks. Generally, when stocks or funds are sold, capital gains taxes are paid on any gains that occurred during the period of ownership. When stock is inherited, the cost basis is based on the fair market value of the stock or fund at the date of death.

Artwork and Jewelry. Collectibles, artwork, or jewelry that is inherited and sold will incur a tax on the net gain of the sale. There is a 28% capital gains tax rate, compared to a 15% to 20% capital gains tax rate that applies to most capital assets. The value is based on the value at the date of death or the alternate valuation date. This asset class includes anything that is considered an item worth collecting: rare stamps, books, fine art, antiques and coin collections fall into this category.

Speak with an estate planning attorney before signing and accepting an inheritance, so you’ll know what kind of tax liability comes with the inheritance. Take your time. Most people are advised to wait about a year before making any big financial decisions after a loss.

Reference: Orange Town News (May 29, 2019) “Will I Pay Taxes on My Inheritance”

Sims & Campbell, LLC – Annapolis and Towson Estate Planning Attorneys 

What You Need to Know about Trusts for Estate Planning – Annapolis and Towson Estate Planning

There are many different kinds of trusts used to accomplish a wide variety of purposes in creating an estate plan. Some are created by the operation of a will, and they are known as testamentary trusts—meaning that they came to be via the last will and testament. That’s just the start of a thorough look at trusts offered in the article “ON THE MONEY: A look at different types of trusts” from the Aiken Standard.

Another way to view trusts is in two categories: revocable or irrevocable. As the names imply, the revocable trust can be changed, and the irrevocable trust usually cannot be changed.

A testamentary trust is a revocable trust, since it may be changed during the life of the grantor. However, upon the death of the grantor, it becomes irrevocable.

In most instances, a revocable trust is managed for the benefit of the grantor, although the grantor also retains important rights over the trust during her or his lifetime. The rights of the grantor include the ability to instruct the trustee to distribute any of the assets in the trust to someone, the right to make changes to the trust and the right to terminate the trust at any time.

If the grantor becomes incapacitated, however, and cannot manage her or his finances, then the provisions in the trust document usually give the trustee the power to make discretionary distributions of income and principal to the grantor and, depending upon how the trust is created, to the grantor’s family.

Note that distributions from a living trust to a beneficiary other than the grantor, may be subject to gift taxes. Those are paid by the grantor. In 2019, the annual gift tax exclusion is $15,000. Therefore, if the distribution is under that level, no gift taxes need to be filed or paid.

When the grantor dies, the trust property is distributed to beneficiaries, as directed by the trust agreement.

Irrevocable trusts are established by a grantor and cannot be amended without the approval of the trustee and the beneficiaries of the trust. The major reason for creating such a trust in the past was to create estate and income tax advantages. However, the increase in the federal estate tax exemption means that a single individual’s estate won’t have to pay taxes, if the value of their assets is less than $11.4 million ($22.8 million for a married couple).

Once an irrevocable trust is established and assets are placed in it, those assets are not part of the grantor’s taxable estate, and trust earnings are not reported as income to the grantor.

The downside of an irrevocable trust is that the transfer of assets into the trust may be subject to gift taxes, if the amount that is transferred is greater than $15,000 multiplied by the number of trust beneficiaries. However, depending upon the size of the grantor’s estate, larger amounts may be transferred into an irrevocable trust without any gift tax liability to the grantor, if the synchronization between gift taxes and estate taxes is properly done. This is a complex strategy that requires an experienced trust and estate attorney.

Trusts are also used to address charitable giving and generating current income. These trusts are known as Charitable Remainder Trusts and are irrevocable in nature. There is a current beneficiary who is either the donor or another named individual and a remainder beneficiary, which is a qualified charitable organization. The trust document provides that the named beneficiary receives an income stream from the income produced by the trust assets, and when the grantor dies, the remaining assets of the trust pass to the charity.

Speak with your estate planning attorney about how trusts might be a valuable part of your estate plan. If your estate plan has not been reviewed since the new tax law was passed, there may be certain opportunities that you are missing.

Reference: Aiken Standard (May 17, 2019) “ON THE MONEY: A look at different types of trusts”

Sims & Campbell, LLC – Annapolis and Towson Estate Planning Attorneys